Why the P&L Should be Your Least Favorite Financial Statement
There are a couple of problems with a profit and loss statement despite they are importance to a business. One of these problems is they are an “after the fact” accessory to the running of your company. A P&L does an excellent job of giving you a historical scorecard for how well you’ve done, but at the same time you can look at the big profit numbers, open your check book and see the money just isn’t there. Cash flow does not equal profit.
Small companies especially need to focus not so much on their profitability but on the cash flow the business is experiencing. You need to make sure you have enough reserves to pay for your normal expenses like payroll and occupancy costs, but also enough to invest in inventory or equipment, pay taxes when due and repay debts. There are several steps to take to understand and manage your cash flow. First, you need to understand your basic financials, next setting up separate tracking accounts, set monthly goals, and develop a realistic budget.
Understanding Your Financials
Included in your financial statements should be a page titled something like Statement of Cash Flows, or Changes in Financial Position. This statement is underutilized by many business owners and accountants because it is hard to create and explain. However, it can be one of the most important financial statement in your monthly or quarterly reports.
The cash flow statement is the bridge between the cash in the bank as shown on the balance sheet, and the profit (or loss) on the P&L. Starting with the net income, it traces where cash has been spent during the period (called uses) and where cash was generated (Called sources). Looking at this statement you can see that cash was maybe spent (a use) on increasing inventory or more cash was collected on receivables that were billed for the period (a source).
Also, a close look at your existing customers will allow you to see what your projected revenues will be. By looking at each individual customer, you can all determine project priorities and if there are any lingering customer service issues that allow a client to miss a payment deadline. Letting your sales people be a part of the cash focus empowers them to help move potential clients through the sales funnel quickly and efficiently.
Setting Up Separate Tracking Accounts
Some businesses have found it beneficial to open separate checking accounts for major
categories of spending. This is analogous to the envelope method many of our parents used to budget, with one envelope for food, another for rent or mortgage, and so on. A growing business will need four or five of these accounts: a general operating for regular expenses, taxes, owners payroll or draw, savings for expansion or equipment, and possibly one for debt repayments.
The advantage of doing this is the inherent discipline of having money earmarked for specific things. With separate accounts, you can still move money around for short term or emergency needs, but the added layer of transactions gives you the time to consider other alternatives or if the importance of the need or emergency is that great.
Set Monthly Goals
With the basic of you financial position in hand, you can begin to set some monthly or quarterly goals. Starting with your balance sheet start listing the major accounts (cash on hand, accounts receivables, fixed assets, payables, etc.). In a column put the current balance of those accounts. Next to that put realistic goals for what you would like that balance to be at the end of your budgeting period.
Some of the calculations can get complex, so if you are well versed in using a spreadsheet application like Excel or Google Spreadsheets, that will save you a lot of time and frustration. As an example, your accounts receivable balance is a function of your past collection history and sales. Inventory likewise is a function of your current inventory plus purchases minus sales. Don’t let things get too complicated and try to keep it as simple while maintaining a realistic perspective.
Develop A Realistic Budget
Once your goals are in place you can begin to develop a workable budget. This plan will be your company’s marching orders for the next planning period. Sales will know what they have to sale, your A/R department will know what needs to be collected and you will know how much inventory will be needed to achieve your sales goals.
Managing your cash flow is the most important aspect of running a small business. These tips can help get you started in the right direction. If you have questions your accountant or CPA will be able to help.
From the Author:
Kudos for going over my blog. I enjoy covering business and administration ideas. I’m an entrepreneur inside, and appreciate people who wish to grow businesses and contribute to the economy.
This article was sponsored by Neches FCU, with locations in Port Neches, Nederland and Beaumont.
Neches FCU is a Texas credit union and has a courteous and attentive team of professionals ready to provide services to our members. When its doors open at any of the several service centers, the mission of “Ultimate Member Satisfaction” becomes the imperative for every employee. They are respected for a personal, dynamic and upbeat work atmosphere, providing a memorable service experience, and where members are known by name.
Neches has approximately $438 Million in assets with over 45,000 members. Neches FCU is considered by members and the business community as one of the best credit unions in Texas and an actively involved partner, helping our Family, Friends and Community!
Talk to you later!