Kellie Parks is the founder of Calmwaters Cloud Accounting Resources. She crafts processes and automation for future-thinking accounting professionals and business owners who believe in the mightiness of online technology. Certified, partnered, or affiliated with over a dozen cloud applications, she’s also a proud member of the Intuit International Trainer Writer Network and the FreshBooks Partner Council.
Profit and Loss (P&L)
This report shows how much you are selling and buying over a given time. It is in order of income and direct costs related to generating that income, then expenses you can claim, and then other income/expenses.
- Income – sales
- Cost of Goods (or Services) Sold (COGS/COSS)- the cost of products and services you need to purchase to directly create sales
- Gross profit – income minus COGS/COSS
- Expenses – the cost of items and services you need to keep your business running, regardless of how many sales you generate
- Other income and expenses – income and expenses that are not a core part of your business
Income is how much you are selling. It is also important to track what you are selling, so you may want to have sub-accounts under your header of “income” to paint a more thorough picture.
“Controlling your spending is important, but you can only make strategic decisions if you know how much income is coming in, how much you are spending, and where you are spending it.”
There are many ways that COGS/COSS tell a story. They are the costs directly related to your sales. They could be merchant fees, widgets purchased to manufacture products or e-commerce platform fees – any product or service tied directly to a sale. For example, let’s say that you are an online retailer or service provider that is paid at the moment of sale. Maybe your payment processor takes a percentage or your sales platform charges you fees. You don’t have a slow payment problem and you’re not “financing” your customers, but you still have high fees associated with your sales. COGS/COSS account explains how your sales are great, but the gross revenue is not. Understanding the costs associated directly with sales will help you plan ways to reduce those expenses.
Expenses, however, are what you need to pay even if you don’t make a single sale, such as rent, fixed payroll (admin, managerial), business software, travel, etc.
Controlling your spending is important, but you can only make strategic decisions if you know how much income is coming in, how much you are spending, and where you are spending it to support the sales or keep the business itself running smoothly.
Your P&L account may tell you that you have lots of revenue. But if your customers are slow to pay, your Accounts Receivable (AR) account on your Balance Sheet (BS) will be high. The BS AR account tells you how much you are owed. The open, slow-paying, overdue client invoice data that sits on your BS then tracks to the Statement of Cash Flows (SCF). SCF reports explain why you have good sales but not enough available cash.
Balance Sheet (BS)
Your Balance Sheet is the value of your business at a point in time: how much you owe and are owed your assets, and your liabilities. It is ordered from good to cautionary news, with a tie out to your current profit/loss number and your retained earnings at the end. The BS is the sum of all the business transactions you have ever done, the full story of your business.
“The BS is the sum of all the business transactions you have ever done, the full story of your business.”
- Bank accounts and actual cash – the amount of money that the business has
- Current assets – what you have/will likely be realized within 12 months:
- Accounts Receivable – how much you are owed from customers
- Long-term assets – things you own and/or things that have long-term value:
- Property, plant, & equipment
- Money owed to you that is not sales-related
- Equity – owner investment, preferred shares
- Short-term liabilities – what you owe:
- Credit cards and short-term notes
- Accounts Payable (AP)- how much you owe vendors
- Long-term liabilities – what you owe for the long run
- Retained earnings – money left over after paying all obligations and after paying out dividends
- Profit/loss – sales less expenses at a point in time
Retained earnings is a key number that paints a picture of carry-forward income/loss and signals whether you can take funds out of your business as more dividends, R&D, or new equipment.
AP and AR flow from the P&L (invoices and bills) is key to determining whether you have overdue balances. It tells you that you need to tighten up terms for customers and perhaps get better terms from vendors. This shows on the Statement of Cash Flow (SCF) in that your cash is being paid out to vendors while you are holding customers’ balances.
The Equity and Current Assets numbers on the Balance Sheet will tell you if you have put in or taken out too much money (personally or as partners), which can tie to the SCF.
Statement of Cash Flow (SCF)
SCF tracks where your money is coming from and where it is flowing out to in comparative periods; how much money you had to spend last month; and how much you have now. Profit DOES NOT equal cash (flow).
- Operating accounts – what money is coming in and going out
- Additions to cash:
- Decrease in AR (customers paying you)
- Subtractions from cash:
- Decrease in AP (you are using money to pay your bills)
- Decrease in taxes payable (you are using money to pay your taxes)
- Increase in inventory (you are buying products)
- Additions to cash:
- Investing accounts – what you are spending to grow your worth
- Financing accounts – how much you are paying out to have what you have
“Profit DOES NOT equal cash (flow)”
Final notes on reporting to consider
- Number your chart of accounts (or have your accounting professional number it for you). Your accounts will be sorted into a more meaningful order.
- Use sub-accounts. You will have the option of granularity, or you can collapse your reports for easy-to-view financials.
- Use comparative reports for the P&L and the BS. It is not enough to know where you stand this month or YTD. You must compare it to previous periods so you can track whether you are growing or shrinking in important accounts.
- The Profit & Loss monitors your finances for a period of time. Key elements of the P&L track to the BS, such as unpaid invoices and bills.
- The Balance Sheet gives you a picture of the value of your business in a moment of time. A combination of activities is tracked from the P&L and the BS to the SCF.
- The Statement of Cash Flow tells you how much cash to grow or if the squeeze is on your business. Profit DOES NOT equal cash (flow).