Language of business is finance

If you’ve ever traveled to a foreign country you probably did a little preparation before your visit. You checked out the maps, worked out your itinerary, and spent a little time learning some of the language. It wasn’t necessary to be a fluent conversationalist, but you wanted to know some of the key local phrases such as, “Where is the bathroom?” or “I want a beer.” Perhaps not in that order.

The language of business is finance. You don’t have to speak it fluently. You can use an outside accountant when it gets complex. But you need to understand the basic financial statements if you want to understand how your business is doing.

There are three primary business statements that business people both big and small should be able to read and understand: the income statement, the balance sheet, and the cash flow statement. Together, this information tells you where your business stands.

The income statement — also known as the profit and loss statement or P & L — shows how much net income or loss a company has had over a specific time period. The income statement contains the revenue or sales the company has earned and deducts the costs of the goods or services sold to calculate the company’s gross profit margin. Operating and administrative expenses — often known as overhead costs — are deducted from the gross profit margin to get to net income, or the profits the company has achieved during the period. Examples of operating expenses range from marketing expenses to travel, utilities and office supplies.

The balance sheet shows what a company owns, what it owes, and the company’s value to its owners at a certain point in time. The asset side of the balance sheet lists items that the business owns, such as its cash, receivables, inventory, and equipment. Assets are usually listed as current and non-current. Current assets can be turned into cash quickly or at least within a year, in order to satisfy creditors or pay bills. The liability side of the balance sheet lists items that the company owes, or rights that others have to the business. Examples include accounts payable or outstanding loans that must be repaid. Liabilities are also broken down into current and non-current, with current liabilities requiring payment within a year. The current ratio, which is current assets divided by current liabilities, is a quick indicator of a business’ liquidity and its ability to pay its upcoming obligations.

The final piece of the balance sheet is owner’s equity, which is the difference between assets and liabilities showing how much a company owns compared to what it owes. Part of owner’s equity is retained earnings, which is the cumulative earnings of a company that have not been paid to the owners. If the company has been losing money, it is possible that owner’s equity may be negative. By definition and accounting convention, assets will always equal liabilities plus owner’s equity.

The income statement and balance sheet provide a great deal of information to gauge financial health, so get familiar with them and pay attention to how the numbers change over time.

The third important financial statement? Cash flow statements are critical and often overlooked, so I’ll tackle them in next week’s column.

Do you have a business question or topic that would make a good column? Send your ideas or questions to jeff.neuville@b-assistnc.com and share your business experience with others.