A couple of months ago, my husband and I took a bucket-list trip to the Netherlands. One morning, we stopped for breakfast at a restaurant in a small village. We slid into our booth and opened the menu; it was in Dutch. We asked for an English menu, as we’d done throughout our trip, but this restaurant didn’t have one.
There were a few pictures on the menu, which helped a little, but most of the menu was a mystery to us. So, I got on the Wi-Fi and started using google translate on my phone. That was also helpful, but very time-consuming and tedious. Our waitress noticed our struggle and found another employee who spoke English and helped translate for us.
Do you feel like your financial reports are in another language?
If you’re like most business owners and leaders, you probably have a similar experience when opening your monthly financial reports. You can read the words and the numbers (like I did with my Dutch menu) but still not be sure what they mean. It’s like your financial reports are in another language.
You can have a great product or service, but if you don’t make, have, or keep any money, you will be out of business. That’s why it’s so important to understand the story your financial reports are telling you. Here’s a handy translation guide for two of your basic financial reports:
- The Balance Sheet reports a snapshot of your financial position at a point in time. There are three components of your balance sheet:
- Assets report the value of what you have and what is owed to you.
- Liabilities report obligations you have to others.
- Equity is the accumulation of your capital investments, plus (or minus) your profits and losses, less dividends or distributions.
Assets and liabilities are classified as current or long-term. Current means it’s expected to convert to cash (received or paid out) within one year. This classification provides additional insights into current resources and obligations compared to those that are long-term, but only if the classifications are accurate. Failure to carefully evaluate whether items are properly classified as current or long-term can give you an inaccurate picture of where you stand.
- The Income Statement, also referred to as the Profit & Loss statement (P&L), reports your activities over a period of time, such as a month, quarter, or year. To be most effective, you should review your P&L in comparison to your budget and to the prior year. There are three basic components of your P&L:
- Revenue is the money you earned by selling goods and services.
- Expenses are the costs you incurred.
- Profit is the money you have left over.
Expenses are segregated into two main categories: cost of goods sold and operating expenses. Cost of goods sold represents the direct costs of producing the goods and services that were sold. Operating expenses are costs not directly tied to the production of goods or services.
It’s crucial to accurately classify expenses between cost of goods sold and operating expenses. Then, you can calculate your gross profit margin, which is how much money you make from the products or services you sell (gross profit margin = revenue – cost of goods sold).
Money Tells the Story of Your Business
When you learn the language (or find a great translator), the money will tell you everything you need to know about other facets of your business. Your basic financial reports reveal:
- The liquidity of your resources.
- How you could be more profitable.
- How you could show a profit, but not have much cash.
- How you have cash but show a loss.
To help you translate your financial reports into actionable insights, download this quick reference guide and use it each month. It includes questions for each of the four items above, so you can understand the story your financials are telling about your business.