Understanding income statements and cash flow statements
Income statements and cash flow statements are key to obtaining a complete picture of your business finances.
As a business owner, you probably encounter a wide variety and large volume of financial reports. Two of the most important ones for assessing the health of your business are income statements and cash flow statements.
Here's why you need to understand income statements and cash flow statements, as well as other cash flow tips.
What's the difference between income statements and cash flow statements?
An income statement — also known as a Profit & Loss (P&L) report — shows how much money your business makes and spends within a given time period. In other words, it summarizes how your business earned revenue, paid expenses, and arrived at its bottom line.
A cash flow statement shows the incomings and outgoings of your business's cash within a given time period. This type of report typically divides cash by use:
Financing: Cash used for borrowing or lending
Operations: Cash used during daily operations
Investing: Cash used to purchase equipment or other assets
Why do I need income and cash flow statements?
Income statements and cash flow statements present different yet related information, and the picture of your company is incomplete without understanding both.
Cash flow statements, for example, provide the shorter-term information you need on a daily basis. Your cash flow statement can help you answer questions such as: Can I afford to pay my bills? Do I have enough cash for unexpected equipment repairs? Will I be able to fund payroll on time?
Income statements, on the other hand, provide the bigger picture. They account for financial factors beyond cash flow, non-cash expenses such as depreciation, and allow you to observe your business's longer-term trends in spending and earning. Your income statement can help you answer questions such as: How did my business perform last year? Where can I cut back on costs? Will lenders trust me to repay their financing?
What's the difference between gross revenue and net income?
Two additional factors that track the health of your business are revenue and income, but it's important to understand the distinction between the two.
Gross revenue: The total amount of money your business earns by selling goods and services, plus any additional income from investments.
Net income: The total profit your business earns after paying all expenses, including payroll, raw materials, taxes, and interest on loans. In other words, net income represents your business's bottom line.
While gross revenue and net income can be similar, they may not always match up. In the startup phase, for example, your business may have several ongoing expenses and one-time expenses, such as the cost of incorporation or paying security deposits, which will cause a difference.
How can I improve my business's cash flow?
Staying in the black can be difficult, especially for startups and small businesses. Here are a few suggestions for staying on top of your cash flow:
Be aware of timing. How soon do customers pay you after a sale? When do you pay your bills? Every dollar you don't have can be a liability for your business's operations, so anticipate when you'll receive and make payments, and plan accordingly.
Save cash for emergencies. Eventually, your business may experience an unexpected shortage of cash. Prepare for emergencies by keeping enough money on hand to cover at least one month of expenses.
Establish a line of credit. In addition to an emergency stockpile of cash, prepare for financial disruptions by establishing a line of credit before you need it. Having a line of credit in place early will help you stay ahead of problems, as banks may be hesitant to lend to businesses with immediate cash requests.
Tracking finances is key to your business's survival and success. Make sure you obtain the complete picture by using income and cash flow statements.