Saturday, January 10, 2009

Mentoring for Managers, Career Development Tools, more from Al Walsh

Financial Statements for Dummies - A Career Development Tool

Don't know how to read Financials?
Paraphrasing the popular “how-to” books, this article is a basic primer on understanding Financial Statements.
It’s scary to me how many business managers can’t read their own company’s Financials. Even some business owners barely understand their own Financials (and, scarily enough, some Finance people too).
Any manager who wants to advance beyond the status of “junior flunkie” should have at least a cursory understanding.
I’m not going to get involved in double-entry accounting and debits & credits. That would just confuse you and it’s unnecessary for this discussion. If you have no idea what I was just talking about, accountants post two entries for every transaction; a debit and a credit. It’s called double-entry accounting. Enough said.
All you accountants out there can now close the article and go away. This is basic stuff.

So here goes:

The two basic Financial Statements are the Balance Sheet and The Income Statement (or P&L).

Let’s talk about the Balance Sheet first:
The Balance Sheet is a reflection of the financial makeup and standing of the company at any point in time - usually at each month-end. It is a roll-up of every transaction the company’s done from day-one to present. It reflects EVERYTHING that’s happened; including Profit or Loss (more on that later).

The Balance Sheet is made up of three broad categories: Assets Liabilities and Net Worth (or Owners’ Equity). The total of Assets always equals the total of Liabilities plus Net Worth. (Assets = Liabilities + Net Worth)

Assets = the things the company owns: Cash, Accounts Receivable, Inventory, Land, Equipment, etc. If you prepay insurance, or some other purchase, you would also post an asset entry here.
Liabilities are the debts of the company: Accounts Payable, Bank Debt, Car Loans, etc. They’re split up between Current Liabilities (the money due within the current fiscal year) and Long-Term Debt (Amounts due beyond the current fiscal year).
Last, we have Net Worth (Owners Equity).
Net Worth contains: Any money invested in the company minus any dividends paid plus the net total of all annual profits (negative for losses) since day one (called Retained Earnings) plus the total of profits (negative for losses) in the current year.

Not too difficult, huh? Now let’s talk about the Income Statement (P&L):
The Income Statement is a reflection of all Revenues and Expenses for the current year; in other words, the company’s profitability. The bottom-line number is Net Profit, which = all Revenues less all Expenses. Remember I said earlier that the Balance Sheet reflects ALL transactions of the company? The Net Profit total of the Income Statement flows to the Balance Sheet as the total of current year profits in the Net Worth section. At each year-end, the Income Statement zeros out to begin a new year. On the Balance Sheet, the current year profit in the Net Worth section transfers to the Retained Earnings total and the current year profit value goes back to zero for the start of a new year. If you’re confused, read this a couple times and you’ll get the hang of it. This is where beginning accounting students start getting glaze-eyed, but it’s not that tough. Just sleep on it.

That basically sums up your two key Financial Statements. There are others, but unless you’re heavily involved in the numbers you don’t have to know those. With an understanding of these two, you can get a decent handle on the company’s status.
I didn’t get into some of the more complex stuff like Capital Purchases vs Expenses, or Depreciation, or some of the hinky accounting transactions, but that’s okay. That’s a set of topics for another day.
If you’re still confused, get your hands on some Financials and go find the categories mentioned in this article. It will come to you.
I hope this helps.

1 comment:

Alison said...

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