Let’s say you’re looking at the income statement for your business and you like what you see. That’s great. But hey… wait a minute. Why don’t your bank accounts paint the same rosy picture as what you see on your income statement?

This is a common question, and it’s one I encounter regularly as the Accounting Coach with Nexstar Network. What I’ve found is that most owners and operators in our industry have a decent handle on reading and reviewing their income statements. The balance sheet does get looked at periodically, but there’s a general lack of understanding surrounding financials, especially when it comes to looking at the statement of cash flows.

Your income statement, your balance sheet, and your cash flow statement all need to be reviewed each month. Each is important, and each tells a different story in your business.

The income statement is where your monthly review should start — it’s where most of your time should be spent, as it measures your day-to-day operations. It’s also the easiest to understand – we can make changes on the income statement and see a direct result.

1. Assets – These are things you own, like your bank balances, inventory, vehicles, and equipment.
2. Liability – This shows the debts you owe, your accounts payable, credit cards, vehicle loans, and payroll liabilities.
3. Equity – This is what’s left over when we take the things we own minus what we owe. Equity is your true ownership left in the company, your capital stock, retained earnings, current earnings, and owner’s draws.

By looking at this information and understanding it, you can begin to do some analysis to measure the health of your company. By looking at your short-term assets measured against your short-term liabilities, you can measure your ability to cover short-term debt and see what would be left over if something happened and you had to pay debt off in a hurry. All this information will also show how much debt your company is carrying, or how leveraged your company is. Knowing this will help you understand how the company is operating, buying assets, and growing. A high amount of debt means your company is going to have more loan payments, which will eat up cash flow and hinder your ability to cover other debts and payments.

Speaking of cash flow, have you ever looked at your profit and loss sheet and wondered why your bank account doesn’t reflect the profits? That’s another common question in my coaching calls. This is where the statement of cash flows comes in – it helps you understand where the money is.  Your statement of cash flows will show all of the changes on the balance sheet throughout a period that affect your bank balance, or that hit the income statement without hitting the bank. This statement will typically start with your net income for the period; then there will be a section for operating, investing, and financing.

Operating is going to show the changes in your short-term assets and liabilities from the balance sheet and how they relate to cash. Accounts receivable is a common culprit for paper profits without cash in hand. If your accounts receivable goes up, it means you’re closing jobs, but not collecting. This will show up as revenue on your income statement and increase profits, but the bank account will be unchanged. Positive amounts on this report should produce more money in your bank; negatives mean less. As a rule, when an asset increases on the balance sheet, it will result in a negative on the statement of cash flows, as it’s assumed that money was used to acquire the asset. When an asset decreases, it will show up as a positive. Liabilities are the opposite – as they go up, they result in an expense to the income statement without cash going out. As they go down, cash is used to pay these off. A positive for liabilities isn’t always good, as you’ll need to pay them at some point.

Investing measures the changes in fixed assets in your balance sheet. For a growing company, this will usually be negative – as the company acquires more assets, it results in negative amounts. A positive would mean the selling off of larger assets.

Financing is going to show long-term liabilities and equity changes from the balance sheet. When money is taken out for a loan, it results in a positive, but as the loan is paid off, it will show as a negative. Equity typically shows changes in the owner’s draw, which is negative.

There’s so much more to all of these financial statements than this introduction. If you’re new to this, don’t worry – lots of owners feel overwhelmed when they’re learning about the financial side of running a company. There’s a lot of information to cover. The important thing is to get in the habit of reviewing more than your income statement. Taking a look at your income statement, balance sheet, and statement of cash flows is a great way to find out what’s really going on with your company.