The pursuit of the American Dream is the aspiration of all entrepreneurs.[cite::219::cite] Working for yourself, leaving your mark on the world or starting a family legacy is incredibly courageous and so exciting!
You’ve secured your business loan, locked down an awesome space to sell or create from, and you even have customers; you are the king or queen of momentum. The next benchmark in your journey, as you know or will soon find out, is to track how your new business is performing. You need to check the pulse of your business, if you will. To do this, you will be running a P&L Statement, or a profit and loss statement, and a Balance Sheet. These tools will help you to see where your business is thriving or diving.
Before taking a deeper look into P&Ls and Balance Sheets, it is important to know the difference between the two and what they mean to bankers, lenders and, most importantly, YOU, the business owner. In a nutshell, P&Ls give you an indication as to whether your business is profitable or not, over a period of time like a month or a year. Balance Sheets, on the other hand, help depict your company’s financial health on a specific date or one point in time.
At first glance, P&Ls can be can be an intimidating combination of numbers, formulas, and acronyms – it’s enough to make your head spin! Unfortunately, you can’t learn to be a CPA from this one blog, but you can pick up some fundamental concepts to help understand what these statements are telling you.
- A P&L is nothing more than the elementary concept of sales minus expenses equal profits or losses
- Vocabulary, vocabulary, vocabulary
- P&L Statement - Revenue Statement, Earnings Statement, Income Statement, or an Operating Statement
- Revenue - Income, Sales and Fees
- Gross Profit - Gross Margin
- COGS - Cost Of Goods Sold
- OPEX - Operational Expenditures or Cost of Service (COS)
- EBIT - Earnings Before Interest & Tax or Profit/Loss
Okay, don’t panic, let’s talk it out.
For the purposes of this blog, let’s say you’re looking at the books for 2016. The P&L starts with 2016’s revenue or the total money your company generated in 2016. To get your Gross Profit, you need to subtract the COGS from the Revenue.
Revenue – COGS = Gross Profit
Once you know the Gross Profit, you can determine the amount of profits or losses for the year by subtracting the OPEX. The OPEX is anything that you spend money on to run your business such as the internet, advertising, employee salaries, etc.
Gross Profit – OPEX = EBIT
So, we now know whether you are seeing a profit or a loss for 2016. To really dig deeper on how your business is performing, run a P&L monthly. You can find out what months are more fruitful than others and then you can research what adjustments are needed to make your business more profitable.
P&Ls are a great way to assess the amount of money being generated and to monitor the amount of money being spent. Many times, there are places where a business can save money by adjusting the OPEX.
Balance Sheets, like P&L statements, are pretty straight forward. But, to keep it all straight, let’s get some definitions out of the way.
Asset – What a business owns
An asset is broken into current and long-term. A current asset is any capital in a bank account along with anything that the company owns, such as equipment, furniture, cars or trucks, or something similar that lasts for years and can be converted into cash. Balance Sheets can also include money owed to you by a customer, which will live under an account-receivable balance. Long-term assets, or assets that are not easily turned to cash, such as investments or buildings.
Liability – What a business owes
Current liabilities are amounts due within the year for taxes, employee salaries, money owed to vendors, and day-to-day bills, which should be on their own accounts-payable sheet. Long-term liabilities are amounts due over a year such as any loan the business is paying on or deferred taxes.
Owner’s Equity – Capital or Net Worth
This is what has been invested in the company. It can consist of what you personally invested, what you and your partner have invested and/or what your stockholders have invested.
Now, to check your company’s financial health and make a Balance Sheet, you need to pick a point in time and establish all assets, liabilities, and equities. To do this, take a sheet of paper and fold it in half. On the left side, list all of your assets for that point in time and add them together to get total assets. Then, on the right side of the paper, list all of your liabilities, followed by your owner’s equity and add the sums together to get a total for liabilities and equity. These two totals, your assets, and liabilities plus equity, should be equal for your books to be “balanced”.
Assets = Liabilities + Owner’s Equity
This is a high-level overview of how to get the pulse of your company’s financial standing. By using these assessments together, you can determine the operational efficiency of your company and be better equipped to determine the direction of the company’s future. It is, however, recommended that you speak with a professional to ensure that your new business is set up for success.