Let’s begin by defining an entrepreneur and financial statements as we will continue to use and refer to these words up to the end of the article.
An Entrepreneur is any person who organises and operates a business. It is a person who sets up a business with the aim of earning a return or profit. He or she makes decisions, plans and implements them in the business with the aim of creating wealth.
Financial Statements refer to “written records that convey business activities and financial performance of a company”- Chris B. Murphy. Financial statements information knowledge enables an individual to make appropriate financial decisions of the business.
You will realise that business decisions in one way or another will end up with financial implications on the entity. “In the world of business, the people who are most successful are those who are doing what they love” Warren Buffet noted. You need to love the financial statements to get the best out of them as entrepreneur.
I will tell candidly that I studied accounting, and am a professional Accountant, but what an accountant looks for in the financial statements is different from what the entrepreneur looks for. It is until I started investing and doing business, that I saw the major difference. I want to emphasise to you that you will need an Accountant certainly, but your decisions will be enhanced more once you appreciate financial numbers and what those numbers mean to your business.
Why financial statements for entrepreneurs?
Every day an entrepreneur makes decisions. Whatever those decisions are, they end up having financial implications on the entity both internally and externally. The entrepreneur needs financial statements knowledge to;
Understand how financial actions taken affect financial operations of the business. Every decision an entrepreneur makes has implications on the business. If he or she makes a decision to pay workers today, it means that cash at hand or bank will reduce by the amount paid and expenses will equally increase by the same amount. Whatever decision an entrepreneur makes translates in financial terms at one point either now or later. Therefore, a clear of understanding of the effect of each decision on the business is fundamental.
Appreciate what financial numbers mean to the business
The understanding of financial numbers leads you into what drives the business, which leads to the root cause behind those numbers. For example, the number of products you deal in, the sales volume, the prices of the products, the number of staff, the number of sales people all end up in financial numbers. A deeper look at the effect of each number will enable you understand whether there is growth or decline or stagnation.
Measure financial performance of the business
Measuring your financial performance helps you to monitor, remember “If you can’t measure it, you can’t improve it.” – Peter Drucker observed; therefore, you cannot monitor and improve what you cannot measure, you need to keep on top of the game.
Meet internal and external financial requirements of the business
On a day today basis, an entrepreneur needs financial information for use within the operations for decision making of the entity such as cash, stock, debtors. This same information is required for external use and engagements for example with banks if you need a loan, creditors to discuss the credit period they can give you among others for business decision making.
Keep alert on critical financial aspects- financial dashboard indicators
For a car, the dashboard sends signals to the driver that fuel is running low, that temperature is going up, engine check among other dash board signals. While for the business, the dashboard indicators to the entrepreneur are the financial statements that send signals to act on. If you cannot read the business signals, from the financial statements on regular basis, then you are driving without looking at the dashboard.
The understanding of basic financial statement information will enable the entrepreneur to keep alert, take action and in control of the business.
The three fundamental financial statements to master
The fundamental financial statements are balance sheet, income statement and cash flow statement. Every entrepreneur needs to appreciate the three financial statements for whatever size of business, whether small, medium or large. As any financial transaction an entrepreneur makes has an effect on one, or two or on all the three financial statements.
1. Balance sheet
The balance sheet summarises the assets of an entity and what is used to finance those assets. The balance sheet has two parts, the asset side that covers current assets and non-current assets while the right side covers the liability (current liabilities and long-term liabilities) and equity (owner’s funds).
It’s a snapshot of a company’s financial position. You can quickly view your position on – Cash, Inventory, Debtors, creditors, long-term debt and profit all in one sheet. This allows quick information for decision making. Days are long gone when you would wait for a month to have a financial report from your accountant. You can now ask for some information daily, weekly or monthly.
Presents company’s capital structure. You are able to see and observe how the company is financed and determine the strength or weakness of the company.
Visualise ratios required for comparison and decision making. You can pick certain ratios to keep watch over and always compare with ease to the industry standard ratios.
Assess your business negotiation capacity for credit supplies or loan or for selling shares. You will always need to negotiate for your business. For example, for more credit, loan or buying long term assets. Having figures and the reasons behind those figures is a strong tool for your negotiation.
2. Income Statement
The income statement summarises revenue and expenditures of the business to determine profit or loss. It is sometimes referred to as a statement of profit or loss. It is simplified as revenue less expenditure leading to a profit or loss. It provides vital information on:
Profitability of the business and returns to the owners. The entrepreneur is in business to make and create wealth for the enterprise. The income statement informs you on whether you are making profits or losses? You are then able to identify the underlying factors and any adjustments required?
Identification of income sources to the business. An entrepreneur is able to identify whether all sources of income to his business have included. If any source is not included, then revenue will be understated.
To identify whether income reported related to the period of reporting. Facilitates identification of whether all income reported relates to the period of reporting. For example, if the closing inventory was not deducted, cost of sales would have been overstated thus increasing expenses by the closing inventory amount.
Identify and monitor significant expense items for your business. Enable to identify significant expense items in your business to pay close attention to. This may necessitate you to review and consider whether all the costs must be incurred in the subsequent period.
Facilitates analysis of the impact of taxes and other compliance requirements Identify and monitor the compliance aspects to the business and can easily be left out; the major one being taxes, check out for other compliance aspects and whether you are complying with them as well.
The cash flow statement tracks the cash movement of the business bearing in mind that cash is at the heart of the business. Cash comes in or gets out, this is a very important area to pay attention to because it is the gate way of the business. It summarises cash in and out from operations, investments and financing activities. Why cashflow:
Cash is your key performance indicator as an entrepreneur. Cash is a measurable and solid way of assessing your company’s value. Please note that Investors, Creditors, Banks and other Partners pay a lot of attention to cash when looking at your financial statements. You must pay a lot of attention too.
Measuring the rate at which assets can be converted into cash. The entrepreneur strategic role is to analyse the cycle within which assets are converted into cash. The faster the rate of conversion and the shorter, the conversion time, the faster the cash inflows. This implies that the business can continue to get cash at short intervals to meet its obligations. Where the rate of conversion is low, as an entrepreneur, you must have a cash or facility buffer to take care of your business requirements.
Facilitates survival in hard times. With a Covid-19 or recession, businesses without cash will quickly be forced to downsize and are at a risk of running into bankruptcy. On the other hand, businesses with cash will have time to adjust and flex to hard times thereby building resilience for survival.
Emergency times. Businesses need cash to handle unexpected expenses such as disasters, where it may not easily be possible to look for cash elsewhere to handle them at short notice.
Discounted assets. An entrepreneur needs cash to advantage of opportunities to purchase valuable items at discounted rates.
In summary as an entrepreneur, remember:
Balance sheet provides a snapshot of your business financial position, financial indicators and ratios that can be used to monitor operations.
Income statement facilitates you to keep a close eye on your revenue streams, cost structure and profitability trends.
Cash flow matters most in business, “never take your eyes off the cash flow because it is the life blood of business” – Richard Branson. Always match your cash inflows to your outflows as any difference can be very costly.
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Dr. Charles Barugahare (DBA, FCCA)