Financials, our first fundamental in the Five Fundamentals, is one of the most important elements for a growing business. Accurately tracking financial data plays a crucial role in monitoring the overall health and stability of your company. Although the endless number of spreadsheets, checklists and calculations may seem overwhelming, they are essential for running day-to-day operations and even more important when seeking funding from lenders or investors. Financial reporting can help ensure your products and services are priced correctly, identify margins and determine your cash flow.
Here are a few best practices to embrace when recording and preparing financial data:
1. Keep Your General Ledger Current
The general ledger is a master record of your company’s activities. It’s made through transferring journal entries of a company’s financial transactions from its accounting journal entries to one all-encompassing document.
Each time a business makes a financial transaction, it adds a journal entry in their accounting journals. Companies list these transactions in chronological order, by amount and accounts that are affected and in what direction those accounts are affected. Then, the transaction is recorded in the general journal or one of the special journals (sales journal, purchases journal, cash receipts journal, etc.) for the most active accounts.
While the accounting journals contain much of the details, the general ledger is used for viewing the big picture. Once financial transaction entries are made in the general journal, they are summarized and entered in the general ledger; each account on a separate page.
Business owners use the general ledger to prepare financial statements, research out-of-balance conditions and internal and external audits. The ledger lists all of the company’s assets, liabilities, equity, revenue and expenses, and the balance of each.
- Assets are short-term cash and investments and long-term possessions that can be used to run a business.
- Liabilities are debt and other obligations that still need to be paid.
- Equity is the remainder. It represents the value left to the owners of the company.
- Expenses are economic costs a business acquires through its operations to earn revenue.
- Revenue is the amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise.
The general ledger is one of the most important documents used to monitor and control the financial operations of your business. An accurate ledger goes a long way when the company conducts an audit, as auditors will be able to see the detailed explanation of income and expenses.
2. Track Financial Health Through Accurate Financial Statements
There are many spreadsheets and statements that come with keeping your financials in order. Here are three most common financial statements for small business owners:
The balance sheet is a financial snapshot of your business, showing all your assets, liabilities and equity at a point in time. Assets must balance to equal liabilities and owner’s equity.
There are two types of assets, current and fixed assets. Current assets are cash and holdings that you plan to sell within a year. Fixed assets are items you aren’t selling such as machinery equipment, land, and buildings.
Assets must balance to equal both long and short-term liabilities. Short-term liabilities are accounts payable and taxes. Long-term liabilities are bank loans or notes payable to stockholders.
The income statements, also known as the profit and loss statement, allow you to project sales and expenses over a period of time, usually either a year or three-month quarter. This statement shows the profitability of a company by providing an overview of the company’s sales and net income. Net income is calculated by taking revenues and subtracting the costs of doing business such as depreciation, interest, taxes and other expenses.
Through calculations, analysts can find ratios such as return on equity (ROE), return on assets (ROA), gross profit, operating profit, earnings before taxes (EBIT) and earnings before interest taxes and amortization (EBITDA).
Cash Flow Statement
The cash flow statement highlights how much money is coming in and going out of your business. It helps a company develop an accurate budget. Cash inflows are cash sales, loans and investments. Cash outflows are equipment purchased, expenses paid and inventory. To get the end cash balance, add your cash inflows and subtract cash outflows from your beginning balance.
This statement allows investors to recognize how a company’s operations are running, where money is coming from and how it’s being spent.
The balance sheet, income statement and cash flow statement are useful tools to monitor how well your company is operating. These statements are typically produced at a minimum on a quarterly and annual basis and submitted with your tax return.
Small business investors review a company’s financial statements before considering investment. Three common pieces of information investors look at are earnings and revenue growth, cash flow trends and debt load.
3. Build Financial Transparency
An important aspect of growing a small business is implementing a culture of transparency. Sharing financials with employees gives them a sense of ownership and commitment, potentially decreasing fraud and reputational risks.
Financial transparency means that an outsider should be able to easily read and understand the financial statements of a company and plays an essential role in securing business loans or investors.
Financial accounting relies on certain accounting standards called GAAP, or Generally Accepted Accounting Principles. These standards are aimed to improve the transparency in financial statements by allowing companies to prepare consistent statements each year. U.S. regulations require companies to follow GAAP when releasing financial statements to the public. Companies with stock publicly traded are required to have their financial statements audited by independent public accounts, certifying the materials were prepared in accordance with GAAP.
To ensure financial transparency, follow a few rules:
- Implement strong financial controls and use third party auditors
- Separate financial duties; make sure different employees are in charge of initiating, recording and approving transactions
- Use independent auditors to provide an accurate and fair assessment of the company’s transactions, financial position and cash flow
Sound financial planning requires engagement throughout the year, and an essential way to encourage that is by providing greater real-time visibility into analytics, trends and results.
Monitoring and recording your company’s finances can give your board members, shareholders and future investors a clear picture of some of the most important aspects of your company. Keeping up with the constant process of recording transactions and making calculations will help increase your company’s productivity and create a foundation for better decision making and the growth ahead.