If you’re going to capture value and keep on doing so, injecting it back into the company so that it can keep growing, and capturing more value, you will need to establish financial control over the business as well as the operational controls that the SOPs have given you.
You don’t need to over-complicate this.
Remember “Your First Income Statement”? That’s the first financial control sheet. You need to know how you’re making money from your sales and investments, and the income statement will do exactly that.
Remember that you can build a basic income statement from a system of envelopes too. The first money from sales goes into buying tomorrow’s inventory (or paying for today’s), the second goes into paying overheads (rent, utilities), third to staff (you), fourth to pay the interest and some principle on any debt you owe and the remainder for future investment.
It might seem a little basic, but its particularly good practice as it is closer to cash accounting than the accrual accounting that makes up a proper income statement.
Proper income statements use some guess-work and fiction that accountants like, because it estimates the future. Cash accounting doesn’t make anything up. Instead it just tracks the cash in and out, like a simple cash flow statement, another form of financial control.
In many ways, while we all like to know we are making a profit, it’s more important to know that we are making cash profits, and that we are managing our cash flow, because it is the lack of cash controls that causes many new businesses to fail.
You can add to your envelope-style cash accounting by predicting when you need to pay different accounts. You may not need to pay your supplier every day, and you probably won’t be paying rent daily, so you can build up and predict how much you need in those different envelopes and by when.
This will move you closer to a “proper” income statement, while also establishing cash controls and estimates for how much capital you will need to keep running.
Proper cash controls will minimise the amount of capital you need to keep your business working, or “working capital”. That is:
- The money tied up in inventory,
- The money people owe you,
- And the money you owe people.
We will look at working capital more closely soon, and learn how to work it more aggressively, but before you try that, you must have control over it, and understanding how much you need to pay bills, and when, is the first and most crucial step in that.
This is the beating heart of our business, the engine of our machine, the part that turns over the fastest, and needs to be most closely managed. Understand this and you will have moved a big step closer to business success.
For now, all you need to understand are the very basics of what financial statements should show you:
Income Statements
Income Statements show the profitability of a business over a particular time-frame, often a year or half a year: how much sales, how much estimated (rather than cash) costs, leaving how much profitability. More is good.
Balance Sheets
The balance sheet is a snap-shot estimate of the assets, debts and equity value that is in your business, often done at the end of a year.
Your total assets (all the cash you have plus all the things you’ve bought and not sold) minus your debt (everything you have to repay to anyone) is what the business is worth.
It actually is that simple.
Cash Flow
Cash flow is how much money went in and out of the bank to do all of those things. It should look a lot like your income statement, plus and minus any big changes to the balance sheet.
If you can understand those three simple things, you can have enough control over your finances to run your company, and make it a much more efficient machine.
You might even make it efficient enough that you get your business for free!