Financial Reporting 101: Which reports should I review and how often?
As a small business owner, how you imagine your business is performing and how it's actually performing can be two different realities. Nobody likes surprises, especially when tax time rolls around. Reviewing your financial reports regularly is a great way to make sure how you think your business is performing accurately matches up to how it is performing.
Financial reports are essential to your business’s health because they allow you to feel empowered when making important decisions. Instead of just relying on your gut, financial reports allow you to factor in hard data.
In this article, we’ll break down:
👉 the three most essential financial reports every small business needs to start with
👉 how these reports are related and how they differ from each other
👉 how often you should be reviewing these reports
What is a Profit and Loss Report?
Your Profit and Loss report (sometimes called a “P&L”) will show you how much your business has spent and earned over a specified period of time (such as a month, quarter, or year). It will also tell you if you’ve made a profit or a loss during that time period--hence its name. While a P&L won't tell you everything you need to know about the current state of your business, it's a great report to start with because it WILL tell you if a certain period of time has been profitable for you.
What is a Balance Sheet?
A Balance Sheet shows your company’s net worth. It will display a snapshot of your business’s debts and valuable assets, as of today, in three categories: liabilities, assets, and shareholder equity. Liabilities are any loans or lines of credit your business has open. Assets are items like computer equipment, a company car, or machinery used to build your products. Shareholder’s equity is the amount of cash you’ve invested into the business as the owner. The Balance Sheet is useful for entrepreneurs because it offers insights into your business’s liquidity, financial stability, debt management, net worth, and operational efficiency.
How are the Profit and Loss Report and Balance Sheet related?
Confused about what the difference between a Profit and Loss report and your Balance Sheet is? You’re not the only one! To put it plainly, Your P&L tells you what you’ve spent and what you’ve made during a set period of time, and your balance sheet tells you what you own and what you owe at a single moment.
Your Profit and Loss report will be prepared first, and the number it reports at the bottom (your total revenue minus your expenses) will tell you what your net revenue was for that given period of time. It’ll get reported on your Balance Sheet as Retained Earnings (because they’re earnings that you were able to keep after all your expenses were taken into consideration).
What is a Statement of Cashflows?
The last of your three essential financial reports is the Statement of Cashflows, a financial document that shows how much cash flows in and out of your business during a specific time. It can help you better understand your spending habits, pointing out ways you spent money well and ways you could better manage your money. It looks at your operating activities (the day-to-day expenses that keep your business running, which is where most of your cash is from), your investing activities (how you’ve bought and sold company assets), and financing activities (think: loans taken out, fundraising efforts, and money obtained from investors).
Keep in mind, this report DOESN’T account for liabilities (money you owe) and assets (things you own). It also doesn’t show any outstanding revenue (AKA your accounts receivable) and upcoming expenses (AKA your accounts payable)
How are the Statement of Cashflows and Balance Sheet Similar?
Your Statement of Cashflows and Balance Sheet will actually show the same ending balance. The difference lies in the purposes they serve: The statement of cashflows will help you achieve an understanding of the differences between your net income (how much you made after expenses were accounted for) and the activity in your cash account. It’s not unusual for an entrepreneur to look at their cashflow and go, “I don’t understand, I thought we made a lot this quarter??” The Statement of Cashflows helps answer this, while a balance sheet will simply show you the financial position of your business as of a specific date.
How often should you be reviewing your financial reports?
A good rule of thumb is to review your financial reports on a monthly basis. Depending on the size of your company and the amount of transactions you have, though, this might vary. More frequent reviews might be needed if you have a high volume of transactions or experience fluctuations in revenue, expenses, or cashflow. In this case, waiting a month could leave you in the dark and hurt profit margins. However, businesses that are stable and have relatively few transactions may be able to get away with quarterly or semi-annual reviews.
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