- Date published
Starting or scaling a business? Get top tips for understanding your financials statements.
Ah, the thrill of entrepreneurship — the glittering promise of innovation and, of course, the occasional existential crisis over whether your balance sheet is actually balanced.
If you’re starting or growing a business, financial statements might seem like a foreign language. However, the numbers unveiled in these tools are as crucial as knowing your market.
Here’s why understanding financial statements and foundational financial principles should be at the top of your to-do list.
1. The Crystal Ball of Business Health
Think of financial statements as your business’s very own crystal ball. They offer insights into your company’s health, performance and future prospects. The Income Statement tells you how well you’re turning sales into profits (or not). The Balance Sheet reveals what you own versus what you owe. The Cash Flow Statement? It’s your business’s lifeline, showing how cash flows in and out.
“In that startup stage, if you’re looking for funding – or even if you’re not looking for startup capital – you have to understand where you’re going and what resources it’s going to take to get there,” said Sandra Smart, technology commercialization specialist and business consultant at efactory.
Understanding these statements helps you identify issues before they become catastrophic. Imagine thinking your business is thriving, only to find out your cash flow is so poor you can’t pay next month’s rent. With regular reviews of your financial statements, you can avoid such shocks and make informed decisions based on data rather than intuition alone.
“Numbers aren’t bad! And understanding them gives you an advantage,” Smart added.
“Give your startup a three-to-six-month cushion of operating expenses. You want to make sure you’ve got enough runway if you’re off on projections.”
2. Navigating the Growth Spurt
As you scale up, your financial landscape becomes more complex. You’ll need to track expenses, manage inventory and handle increased revenue streams. A solid grasp of financial foundations helps you identify growth opportunities and potential pitfalls.
“For businesses that are existing and looking to grow, they may ask, ‘Can I hire additional staff?’” Smart said. “They have to know how much more they’re going to have to sell to cover the change in expenses – whatever additions they might be looking at.”
Smart notes that understanding your financial statements allows you to spot trends or notice rising costs that signal it’s time to renegotiate contracts or your pricing structure. Without financial acumen, these opportunities could slip through the cracks.
3. Attracting Investors and Securing Loans
Let’s face it: Getting investors and lenders to back your business requires evidence that your business is a safe choice. This is where your financial statements come into play. They demonstrate that you understand your numbers and can manage your finances effectively.
A well-prepared set of financial statements makes your business look professional and trustworthy. It tells potential investors and lenders, “I’ve got this under control,” which can make the difference between a successful pitch and a politely declined offer. Investors and banks don’t just want to see a good idea; they want to see a good idea with solid financial information.
Beyond that, Smart added that lenders could see red flags when you lack collateral or have a low credit score.
“If you’re not paying your own bills in a timely and appropriate fashion, what makes anybody think that you’re going to make these payments in a timely fashion?”
4. Strategic Decision-Making
Financial statements are your GPS for decision-making. They help you set budgets, forecast future performance and make strategic choices. Want to launch a new product line? Your financial statements will help you assess whether you have the cash flow to support it and predict the potential return on investment.
“Your statements tell a story about what’s going on in the business, so you shouldn’t be afraid of them,” Smart said.
Moreover, understanding your financials allows you to pivot quickly if needed. If a product isn’t performing as expected, you can spot the issue early and adjust your strategy before it becomes a costly mistake. In business, agility is key, and financial knowledge is your map.
But beware: “Garbage in, garbage out,” Smart said.
Your financial statements are only as good as the information put into them. Whatever accounting system you utilize, make sure you understand each category. Without this fundamental understanding, you could mistakenly place items into the wrong spot, which will in turn make your statements unreliable.
The Bottom Line
Remember, the road to business success is paved with a solid financial understanding, and while it might not be as thrilling as your latest product launch, it’s definitely more reliable.
