Statement of Cash Flow Basics

We’re sticking with the summer reboot here on New Venture Mentor even though daylight saving just happened and we’re clearly well into fall. It was 72 degrees here in Chicago though, so I’m allowing the summer reboot to continue. Anywho, This week we’re doing a five-minute finance lesson on the basics you need to know about your statement of cash flows.

Since I work with first-time entrepreneurs who don’t typically have any background in business management, I spend a lot of time talking with my clients about financial statements and getting them up to speed on what’s what. Now, clearly, nobody is going to become an accountant overnight – nor should you try to – but every business owner should have enough knowledge to understand what an accountant is telling you about the financial state of your business and to be able to read basic financial statements yourself and get the pulse of your business’ health. So, as step one towards that goal I’m giving a series of 3 five-minute finance lessons to give you a brief overview of the three basic financial statements: the income statement, the statement of cash flows, and the balance sheet. This week, we’re covering the statement of cash flows, which is super quick, so this will be a short video.

The statement of cash flows is just as it sounds and shows the flow of cash into and out of your business. The statement of cash flows is incredibly important because one of the key issues faced by new businesses is cash flow. It is possible (and common) for a business to be profitable but to go out of business because poor cash flow doesn’t allow for the timely payment of bills.

The statement of cash flows is broken down into three sections: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Operating activities are those directly related to the main operations of the business and you’ll be looking at accounts such as accounts receivable and accounts payable to help you with this section. Investing activities are those concerned with a company’s investments such as the purchase or sale of a property or the acquisition of another company. Financing activities are those related to financing the business such as issuance or acceptance of debt or dividend payments. Please take a look at the example cash flow statement to get a better understanding.

CashFlowsExample


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Balance Sheet Basics

This week we’re sticking with the reboot and doing a five-minute finance lessons on the basics you need to know about your balance sheet.

Since I work with first-time entrepreneurs who don’t typically have any background in business management, I spend a lot of time talking with my clients about financial statements and getting them up to speed on what’s what. Now, clearly, nobody is going to become an accountant overnight – nor should you try to – but every business owner should have enough knowledge to understand what an accountant is telling you about the financial state of your business and to be able to read basic financial statements yourself and get the pulse of your business’ health. So, as step one towards that goal I’m giving a series of 3 five-minute finance lessons to give you a brief overview of the three basic financial statements: the income statement, the statement of cash flows, and the balance sheet. This week, we’re covering the balance sheet.

The balance sheet gives a picture of a company’s assets, liabilities, and shareholders’ equity (i.e. what a company owns, owes, and who owns it) at a specific point in time. It’s a static picture and will be dated accordingly: Company X Balance Sheet as of December 31, 2013, for example. The balance sheet is based on the following equation:

assets = liabilities + shareholders’ equity

The two sides of that equation must ALWAYS equal each other, so once you start building your financial statements you need to double check that the equation balances. If it doesn’t, you know you’ve made a mistake somewhere. Think of it like this: everything the company owns (its assets) had to be paid for somehow and companies pay for things by either borrowing money (liabilities) or getting the money from shareholders (shareholders’ equity). When you look at the balance sheet in this way, it’s easy to understand 1) why it must balance and 2) what should go where.

The exact items that will be on a balance sheet differ from industry to industry and company to company, however, there are some basics that will show up on almost every company’s balance sheet. On the assets side, you should include items like cash and cash equivalents, accounts receivable, inventory, property, etc. Additionally, assets are broken down into current assets and long-term assets. Current assets are those assets that are considered most liquid, meaning that they either are cash or can be exchanged for cash quickly, and that may come and go quickly. Long-term assets are those that have monetary value but that can’t be exchanged for cash as readily and tend to be held for longer periods of time. For example, accounts receivable would be included under current assets because you can either collect the payment from those who owe you or sell it to a factoring or collections company almost immediately and have access to cash. Additionally, the balance of your accounts receivable is constantly changing. An office building owned by the company, on the other hand, would be included under long-term assets because you can’t convert its value into cash so readily and you’ll likely continue to see it on the balance sheet for years to come. Putting the building up for sale, finding a buyer, negotiating the terms, closing, collecting payment, and transferring title will take a significant amount of time, so this asset is considered illiquid and long-term.

On the liabilities and shareholders’ equity side you’ll also break liabilities down into current versus long-term debt. Current debt is that which must be paid within one calendar year of the date of the balance sheet. Long-term debt is debt which will be due more than one calendar year from the date of the balance sheet. For example, if your company has a mortgage on that office building that we discussed above, the amount owed on the mortgage for the next 12 months will be listed in current liabilities while the amount that will remain on the mortgage after those 12 months will be listed in long-term debts. In addition to the current and long-terms debts, this section of the balance sheet also lists shareholders’ equity.

Let’s take a look at an example to help you understand.
BalanceSheetExample


If you’re an aspiring entrepreneur, the best thing you can do for yourself is to just get started. Pick up my business planning ebook here to be guided through the whole business planning process for less than $5.
More of a video person than a text person? Click here to try my ecourses instead.

Income Statement Basics

I know it’s starting to get chilly out there for a lot of us, but this week we’re sticking with the summer reboot and doing a five-minute finance lessons on the basics you need to know about your income statement, otherwise known as your profit and loss or P&L statement.

Since I work with first-time entrepreneurs who don’t typically have any background in business management, I spend a lot of time talking with my clients about financial statements and getting them up to speed on what’s what. Now, clearly, nobody is going to become an accountant overnight – nor should you try to – but every business owner should have enough knowledge to understand what an accountant is telling you about the financial state of your business and to be able to read basic financial statements yourself and get the pulse of your business’ health. So, as step one towards that goal I’m giving a series of three five-minute finance lessons to give you a brief overview of the three basic financial statements: the income statement, the statement of cash flows, and the balance sheet. This week, we’re covering the income statement.

The income statement, also known as the profit and loss or P&L statement, shows the company’s revenues and expenses over a specified period of time. It’s a bit more of a story than the static picture of the balance sheet and will be labeled accordingly: for example, Company X Income Statement for the period January 1 -December 31, 2013. The income statement is typically divided into operating and non-operating sections, though many new businesses don’t really have non-operating expenses and don’t separate the income statement in this way. The operating section should include all of the revenues and expenses that are directly related to what the business actually does. The non-operating section, by contrast, includes all of the revenues and expenses generated from any activity that is unrelated to the business’ primary operations. For example, if a business has some extra cash lying around and invests it instead of putting it back into the business, any broker fees, etc. associated with the investment and any profits made from it would fall in the non-operating section. Another example would be if a non-real estate company sold one of the buildings it owns – all of the costs and revenues associated with the sale would fall under the non-operating section. Again, these types of revenues and expenses are far less common in brand new businesses, so many business plans don’t include a non-operating section on their income statement.

Of course, the actual line items included on any income statement vary widely from company to company but it is always broken down into revenues and expenses. Expenses will be further broken down into cost of sales and selling, general, and administrative (SG&A) expenses. Cost of sales includes cost of goods sold, which are the direct costs of whatever you sell, plus any additional costs directly associated with the sale. For example, if you are a reseller of widgets and each widget costs you $10 to buy plus you need to package it for an additional $1 and you pay a sales commission of $2 for every widget sold then your cost of goods sold on one widget is $11 and your total cost of sales on one widget is $13. SG&A expenses are those that exist separate from any individual sale. You can think of these costs as the overhead costs of doing business. You need to pay your utilities bills, administrative salaries, rent, etc. whether or not you make a single sale, so these expenses cannot be included in the cost of sales but are, obviously, important to include in the income statement. They will come in under the selling, general, and administrative expenses section.

You’ll then subtract all of the expenses from all of the revenue and subtract out taxes, interest payments, depreciation, and amortization to get your net income for the period. Take a look at the example to walk through the income statement line by line and get a better understanding.

IncomeStatementExample


If you’re an aspiring entrepreneur, the best thing you can do for yourself is to just get started. Pick up my business planning ebook here to be guided through the whole business planning process for less than $5.
More of a video person than a text person? Click here to try my ecourses instead.

 

Business Basics Review: 5 Minute Finance Lesson

I’m on vacation this month so we’re getting back to basics and sharing some of my old videos that have been most helpful in setting new entrepreneurs on the path to successfully planning and launching their new startups or small businesses. This week’s old school video: the 5 Minute Finance Lesson.