Understanding your financial statement
Nosa Uwaifo BEng (Hons), MSc, AMIMechE
Engineering Technical Interface Manager
As an engineer running my own company I have come to realize that there are numerous business skills required to run a company. Depending on the landscape of the market some of these elements are ignored, especially when one is operating in a niche market or has a monopoly. That being said there is one area that is very important to a business, and that is finance. It does not matter whether you are a multinational or a sole trader, being able to understand basic finance is critical.
The three financial statements that are used to judge the financial health of a business especially when investing; the Balance Sheet, Income Statement and Cash Flow. Although I strongly recommend the use of a chartered accountant, it does not hurt to understand how these things are constructed so as to verify your accountant’s work.
So what is a balance sheet? Simply put in layman’s terms it is financial statement of what you own vs who you owe and how you funded your enterprise. As the name suggests the two must equal. It gives a snap shot of your company’s financial status for a given period. Think of it like going to your doctor for a check-up, that check-up is only valid for that day. You cannot complain to your doctor about not picking up on your high cholesterol 6 months down the line after a heavy diet of bacon butties every morning, afternoon and evening.
The income statement (profit and loss sheet) really just tells you how much a profit or loss a company has incurred over a defined period. You could say that it shows how the company got from A to B with reference to its balance sheet. The income statement is a very straight forward analysis of a company’s financial performance. It can how ever give false impression about a company when viewed in isolation, as it does not account for future cost i.e. there could be a pending court decision which could cost the company money. These things are often covered by the notes of the balance sheet.
This now brings us to cash flow. What is cash flow? Once again in layman’s term this could be seen as the flow of cash in and out of the company’s account. Many a business have been forced into liquidation due to poor cash flow management. According to your balance sheet and income statement you cash in the bank, but a lot of this cash is to be paid in the future by your debtors (not actually in the bank, but the tax man does not see it that way), but you have wages taxes to deal with. It is for this reason why cash flow management is important, the more you understand your clients, vendors and the flow of your business’s fund better your able to plan to ensure you creditors are paid.
While I will readily confess that I am no Accountant, I do believe that the above is a reasonably accurate description of three financial statements that constitutes a company’s financial report. So in closing, try to understand your accounts and don’t just be a nodding donkey, question your accountant to ensure accuracy of your financial statements. Review the balance sheet, income statement and cash flow statement to better understand the financial health of your business (just rely on the income state could give a false impression). At the end of the day it is your business and you are legally responsible for all accounts regardless of who put them together.