Finance for Founders - Understanding Your Financial Statements
June 18, 2021
When you go into business, you might not think enough about...well, business. You consider your products and obsess over your customers. But many founders don't go into their startups with the background they need in financial statements.
One study showed that 42% of startup founders began their business either to be their own boss or to pursue their passion. How many said they launched their company to scrutinize financial statements? Roughly zero percent.
This plays into a general trend. Many Americans lack the basics of financial literacy. One Federal Reserve study showed that one out of five adults couldn't score higher than one on a three-point financial quiz.
One Federal Reserve study showed that one out of five adults couldn't score higher than one on a three-point financial quiz.
Of course, as a startup founder, you'll have an edge over the average consumer in terms of your financial knowledge. To maximize your chances of success, you need to have the right background in documents like income statements, balance sheets, and cash flow statements.
These tools will help you get the most out of your startup. Understanding your finances represents the first step to making empowered financial decisions for your business. With that in mind, we'll outline the basics for various financial statements you should familiarize yourself with, laying the groundwork for mastering your finances.
What is an income statement?
When you think of your company's financial statements, an income statement probably comes to mind first. Also known as a profit/loss statement (or just a P/L statement), it boils down your results, letting you see how well your business is doing.
The document starts with your revenue. This is where the term "top line" comes from. It represents the money you generate from selling your goods or services.
From there, you subtract your expenses. This includes both operating costs, such as the amount you spend on raw materials or employees' salaries. It also takes into account non-operating costs - things like depreciation.
In the end, you're left with the bottom line: the profit or loss you posted during the period.
What is a balance sheet?
The balance sheet provides a detailed list of what your company owns and what it owes. This lets you know the total value of your outstanding assets.
It doesn't show you how your company's operations are performing. That information comes from the income statement. Rather, a balance sheet indicates your overall financial situation.
As the name suggests, a balance sheet has two sides. One side includes your assets. These are items that have value. Think of cash in your bank account, the marketable securities you hold, and the property you own. It also includes things like inventory and accounts receivable.
The other side of your balance sheet has your liabilities. These list the amounts you owe to others. Think of items like loans and accounts payable.
What is a statement of cash flows?
A cash flow statement resembles an income statement. The two documents can indicate how well your operations are performing. However, they track slightly different things.
Here, you're following the movement of cash through your organization. An income statement includes non-cash items, such as goodwill and depreciation. Those don't get counted in cash-flow equations. Instead, this document only concerns itself with cash.
This provides crucial information. Cash represents your central financial resource. Knowing how you use it (and how much you have) will let you get the most out of your business.
Learning about the performance of your business
Each of these financial statements tells you something different about your business.
- Income Statements: You get a broad picture of your operations, including cash and non-cash items.
- Balance Sheet: You get a rundown of your assets and liabilities.
- Cash Flow Statement: You can follow how cash moves through your organization.
These documents let you answer specific questions about your business. Together, they provide even more. The documents allow you to make subtle distinctions and draw actionable insights into your operations.
Running a startup or small business requires day-to-day attention to detail. You also need to take the occasional broad view. That's what you get from financial statements. These snapshots of your business let you see how well you are using your resources.
That's what you get from financial statements. These snapshots of your business let you see how well you are using your resources.
As such, understanding these documents provides a crucial first step as you launch your career as a founder. You'll gain control of your small business's finances.
As you launch your startup, step up your financial education. Learn what these essential financial statements are and what information each provides. By doing this, you'll be able to track your performance better. At the same time, you'll be able to make more informed financial decisions for your business in the future.