Understanding financial statements can be difficult for new startups because it doesn’t hold that exciting flair like innovation, design, customer discovery, seed-rounds, co-founder dynamics, and revenue-generation. Don’t feel bad, because here’s an easy-to-follow story that will help you demystify this uncomfortable subject.
Have you ever visited your local physician and received some startling news? Maybe you discovered that you had something as small as a cold, or maybe something very serious like high-blood pressure, diabetes, or even cancer. Or maybe you learned that you have optimum health and a great life ahead of you. A superior doctor will not only explain your current state, but just as important, explain the actions you took to land you into your current health position.
The same is true in business. A great accounting system allows you to know the current financial health of your business, and also your actions that led to that state. Two primary financial statements show us this:
- Balance Sheet – represents your financial health, current state
- Income Statement – represents how you operate, your actions
So the financial state of your business can be good or bad, just like your health.
If you want to understand how you got into whichever position, you have to first understand how you operate, or your actions.
For example, if you are sick (your current state), it would be wise to take it a step further and see how you became that way. What were your actions that lead you to become sick? Do you spend money on unhealthy food, don’t invest in physical wellness and exercise, and choose to stay out late or overwork yourself?
The same thing works for business. If the financial health of your business is poor. Take a look at your assets like your bank account for instance; is it low or shrinking? How about your liabilities? Are they increasing faster than your assets? Whenever the equity, or net worth, in your business is low, you have to change your actions, or how you operate. Changing how you operate entails to things: improving your revenue capacity and/or managing your expenses better.
Financial statements become easier to relate to when we understand how it is parallel to our personal health and daily activities. So in short, financial statements basically tell us our current condition/position, and then the actions we took to get into that condition/position.
Just by realizing this, your financial awareness will increase, and you will gain more control over the destiny of your startup. It changes from flying blind, to understanding the map that will lead you to your destination safely.
About the Author
Edward M. Morrow is an accountant, speaker, and author. He has contributed his expertise through The Young Entrepreneurs Academy (YEA!), SCORE, Georgia Institute of Technology’s Enterprise Innovation Institute, and The 3 Day Startup Global Roundup. Edward created the site, nonaccountant.com to make accounting enjoyable and understandable for entrepreneurs.