Part 4: Stewardship and the Numbers

People walking on pavement marked by numbers

Stewarding the Numbers

Financial statements and accounting jargon can be confusing. What is the difference between accrual accounting and cash accounting? What does double entry mean? How does the income statement impact the balance sheet? Should I focus on my bank account or my profit and loss statement to know whether I am profitable? What terms should I be familiar with and which can I ignore?

Many small business owners have minimal background in accounting and finance. They started their business because they wanted to provide a solution for the marketplace, not because they love numbers. Remember, being a good steward of this business means “the conducting, supervising or managing of something; especially the careful and responsible management of something entrusted to one’s care.” This includes the numbers. Having a basic business finance education is essential to running a successful small business. While the following overview is not a substitute for a more in-depth workshop or seminar, it will provide a good beginning.

The Basics

A basic accounting system should include the ability to generate a balance sheet, a profit and loss statement and a cashflow statement. Every financial transaction in the company flows through one of these instruments.

1. The Balance Sheet

The balance sheet is simply a statement of what you own, the assets of the business and what you owe (the liabilities of the company) at any given time.  The difference between the assets and liabilities is the equity of the company. As a company grows, the items listed on a balance sheet become more numerous and detailed. The following are only a few items from a very simple balance sheet:

Assets

The asset section of the balance sheet includes current assets and long-term assets. Current assets are things like bank account balances, accounts receivable, prepaid expenses and inventory. The assets that can be converted to cash within a year are considered current assets. Long-term assets are made up of the equipment, buildings and land of the company and are unlikely to be converted to cash or sold within the next 12 months. They are subject to a decrease in value over time, so a depreciation amount is assigned to each asset and this accumulated depreciation amount is stated in the long-term asset section as an offset to the original value of the purchased asset.

Liabilities

The liability section of the balance sheet includes everything the company owes or is obligated to pay in the future. A current liability would include any amounts owed to vendors, credit card balances, employee wages and city, state and federal tax obligations. Also, any loan amount due within the next 12 months is listed as a current liability. This is typically the balance on a line of credit and the amount equal to the principal amount due on a long-term loan over the next 12 months. Long-term liabilities include the dollar amount of any debts owed to the bank or others that are not due within 12 months.

Equity

The equity portion of the balance sheet will include the dollar amount of funds contributed by the owner or shareholders that are not considered a loan to be repaid. It also tracks the total amount of distributions that are paid out to the owner or shareholders that are not considered a salary.

Finally, the equity section tracks the accumulated net profit or earnings of the company since inception.

2. The P&L

The profit and loss statement, also known as the income statement, is simply a summary of revenue and expenses over a specifically stated period of time. This statement is usually separated into several different sections:

Operating Revenue

The first section is made up of the operating revenue of the company. Gross sales are identified as the amount a product or service is sold for before any discounts or deductions. After discounts and allowances are deducted from the sale, the result is what is known as net sales.

Cost of Goods Sold

The next section is the cost of goods sold. This includes the purchase of items to resell, the value of inventory used to create the item sold, any shipping costs to bring inventory or product into the warehouse prior to selling the product, any labor used to specifically create the product being sold and any loss or devaluation of inventory while being manufactured, stored or shipped to a customer. The total amount is then listed as the cost of goods sold and is deducted from the net income line to come up with the gross profit.

Expenses

The expense section of the income statement includes all other expenses incurred by the business to operate and accomplish its mission. This section can be categorized in a variety of different ways depending on the industry and the key areas of expenses that a business owner would like to track. Some typical expense categories would include sales, occupancy, personnel, advertising and marketing, office supplies, depreciation and business taxes. Each of these categories may have additionally detailed sub-categories to better detail the expenses the company has incurred.

Net Profit

The net profit is then determined by subtracting the expenses from the gross profit. Finally, the estimated federal tax expense is deducted from this amount to come to the net income of the company. This amount then will be transferred to the equity section of the balance sheet as current earnings. After the close of the fiscal year, the current earnings are transferred to the accumulated earnings line and the current earnings starts the year out at zero dollars.

3. Cashflow Statement

Anticipating an excess or deficit of cash is critical in any business venture

The cashflow statement is a combination of the activity in the income statement and the balance sheet. It shows all of the transactions that either add to or subtract from the cash balance. When a business is using an accrual based accounting system, income and expenses are being recorded as they are incurred and not necessarily when the cash is received or spent. The cashflow statement then shows an increase or decrease in accounts receivable and accounts payable depending on when the cash is received or spent. This is the case for any prepaid expense or accrued liability. The cashflow statement also shows the outflow of cash for the purchase of assets even though this entry is not recorded in the income statement. In the same way, debt, borrowing or payments are listed on the cashflow statement, showing the movement of cash.

With this statement an owner can look at any given period and see what the beginning cash balance was, where the cash flowed in or out, and an ending cash balance. Ideally, this statement would be used to estimate the cash needs for the future as well. Anticipating an excess or deficit of cash is critical in any business venture. As the saying goes, cash is king.

Check back in two weeks for the continuation of this post, the final installment in this 5-part series.


About the Author

Photo of Art Zylstra Art Zylstra brings over 35 years of experience stewarding resources and people to small-to-midsize private and nonprofit organizations to help them flourish and grow. With his MBA in organizational leadership and a doctorate in transformational leadership, Art collaborates with key members of the executive team to develop and implement key strategies across the organization, providing leadership and coordination in its administrative, operation, business planning, accounting and budgeting efforts. He is highly motivated by mission and operates with integrity, confidence, professionalism and resourcefulness in a way that allows all stakeholders of the organization to flourish.

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