Finance fundamentals: Understanding the importance of financial statements

While finance is the backbone of any business, it can often be overlooked by early-stage company founders as they focus on innovation and marketing. Don’t be intimidated by financial statements as you create your business plan and forecast for the future. Here, best-in-class advice from Adam Knust, Sr. Manager – Finance Planning & Analysis, Target and Thai Ha-Ngoc, Sr. Manager – Financial Planning & Analysis, Target on the key elements of a financial statement, the different types of financial statements, and tools to track your finances as you establish and scale your business.  

First, let’s look at the fundamentals of financial planning: 

1. Cash is King (and Queen!)
   We’re sure you’ve heard this adage before, but one factor that’s important for early-stage companies to consider as part of product pricing strategy is the amount of cash you have on hand (which can be accomplished by having a thorough understanding how much you’re making versus how much you’re spending). For instance, if your business is selling t-shirts, you need to understand not only the cost of raw materials, but the marketing, the packaging, processing returns and everything else that goes into your business to properly inform how much money you are actually making. From there, you can properly understand your profit, which allows you to plan for growth in your business. Adam explains, “An exercise you can do to understand this is: How much does it cost to make one unit or one product versus how much will you make from that one product?”  
2. Expenses 
   With growth comes an increase in expenses. Expenses like staffing, marketing and shipping are costs that will change as your business grows. For instance, you may be fulfilling and shipping out orders in your home when you first start your business, but with growth comes expansion and the need for additional logistics costs like a 3PL (Third Party Logistics) warehouse for order fulfillment. 
3. Funding 
   In the beginning stages, your business should be fueling itself in many ways, but as you expand, you will need to fully grasp how your company is funded, be it cash on hand, debt or investors. Each of these has different business implications: debt from a loan will have interest and recurring monthly payments to the bank or investors will ask for equity and a return on this equity. If these requirements are not met, the bank will most likely need to collect some form of collateral and investors may ask for more equity or potentially pull out of the deal. A practical application of funding includes if you get a large order from a store, you will most likely need to secure a funding option in order to produce and deliver the order to the retailer.
4. Growth 
   An important component of growing your business is getting the right level of financing to support your growth. So, for instance, if you aspire to make $100,000 in revenue a year, what types of investments do you need to be making today? 

Now that we have a good foundation on finance, let’s dissect the different types of financial statements. “It is important to familiarize yourself with these types of financial statements if you’re thinking about investors who might be finance savvy and ask how your income statement looks or what kind of debts you have,” Adam notes.

• Income Statement: This statement provides a view of profitability by looking at sales minus expenses.  
• Balance Sheet: This statement captures what a company owns, what a company owes (assets and liabilities) and the difference between the two.  
• Statement of Cash Flows: This statement features where money is coming from, how it is being spent and the cash position of a company over a given period of time.  

Each of these financial statements is typically made up of three sections:

• Sales/Revenue: This is made up of sales from new customers and returning customers. 
• Costs/Expenses: COGS, or Cost of Goods Sold, includes everything it takes to produce a product like materials, production and shipping while other expenses can include marketing, capital investments or asset depreciation. 
• Profit: Profit can be categorized into cash flows and a final cash position which explains how much money the business has made at the end of the day.  

With your new understanding of financial statements, Adam and Thai suggest the following routines to implement for your business: 

1. Regular Financial Review Meetings: Conducting regular financial review meetings allows key stakeholders, including business owners, managers and financial professionals, to discuss and analyze financial performance. Why? It provides a platform for thoughtful decision-making, problem-solving and setting strategic financial goals. 
2. Expense Tracking and Control: Monitoring and controlling expenses is critical for maintaining profitability and efficient resource allocation. A systematic approach to tracking and managing expenses helps identify cost-saving opportunities and ensures that expenditures align with business priorities. 
3. Cash Management: Efficient cash management ensures that the business has enough liquidity to cover day-to-day operations and unexpected expenses. It involves optimizing the timing of cash inflows and outflows to maintain a healthy cash position. 

So, what are some useful tools and platforms that can help you track your finances and scale your business? Read on for some best-in-class resources:
 

1. Excel: Yup, you read that right. Excel is still a great way to plug and play with different scenarios of pricing, expenses and any indirect costs. From there, you can build out your financial projections that can be broken down by year, month and even week. Plus, with Excel, you should be able to get an overview into important insights like when you will be cash flow positive.  
2. FreshBooks: This is a great platform to use for invoicing and general bookkeeping and is affordable for small businesses. Features like categorizing expenses and automatic itemization make it easier on you and your team at tax time.  
3. Shoeboxed: This app makes it easy to keep up with any and all paper receipts that you may receive, making it simple to track and report expenses. Every single expense is important to plug into your financial statements, so don’t forget to track paper receipts. 

Financial health is important to all businesses at any stage. Planning in advance with financial statements and forecasting how you want your business to grow, allows you to strategize exactly how to get there. Implementing these routines into your business practice will allow you to fully optimize your time and energy.