Finance

Don’t know the difference between cashflow and income? A financial guide for aspiring entrepreneurs

Daniel Smith /

Being an entrepreneur is no walk in the park.

While we often hear the success stories of so-and-so who quit their job, started a business and managed to turn a profit in just a few months, these stories tend to omit the not-so-glamorous parts of entrepreneurial life.

In fact, it’s common for entrepreneurs to face total overwhelm within their first few months, or even years in business, due to numerous factors, such as:

  • Not enough time and money available;
  • Lack of proper planning;
  • Having to take on additional roles in the business (such as sales, bookkeeping, marketing and systems administration without prior knowledge);
  • Little understanding of how to use financial resources; and
  • Stress and worry about not making a profit.

Simply put, the entrepreneurial journey can be full of trepidation, with constant worry, stress and fear nagging at the back of our minds.

Luckily, there are plenty of solutions to help navigate the throes of entrepreneurship, one of which is understanding how to use and leverage financial statements.

There are three types of financial statements you need to know: your cashflow statement, income statement and balance sheet.

When used correctly, these statements can serve as benchmarks and guideposts, helping you make better business decisions, assist with tax planning and forecast for the future.

1. Cashflow statement

Your cashflow statement shows you how much money goes in and out of your business within a certain timeframe.

A key point to mention is incoming cash is not recorded when the sale is made, but rather when payments are actually received. In the same way, outgoing cash is not recorded until bills have actually been paid.

Cashflow statements provide a crucial window into the understanding of how money flows in and out of your business. What’s important to understand, is even if you are hitting sales targets and have high-value assets, if your cashflow is stifled or you are waiting on receipt of multiple payments, this could significantly impact your businesses ability to operate.

With the knowledge of how much cash you have available at any given period of time, you will know:

  • When the appropriate times are to spend;
  • How much you have available to pay for necessary products or services; and
  • When to source additional financial resources if needed.

It may even guide you to make changes into the structure of your business to assist with better cashflow.

2. Income statement

Also referred to as a profit-and-loss statement, an income statement displays your income less your expenses for a specific time-period, showing whether you’ve operated at a profit or loss during that time.

This statement can be incredibly eye-opening for business owners. For example, often new entrepreneurs make the mistake of thinking high revenue or sales equates to financial success, without taking into account how much they’re spending. This is why some entrepreneurs find themselves in hot water, despite a heightened focus on sales.

On the other side, perhaps you’ve put attention on how to cut costs and in doing so your sales have taken a back seat.

In this way, your income statement is a trusted business partner, advising you on areas to improve. It holds important insights that will allow you to make better decisions, such as:

  • Where to spend your money for the greatest return;
  • How much you can spend while still making a profit; and
  • Where to focus your energy and resources during the following month.

This might mean focusing next month’s resources on sales, reducing unnecessary costs, or perhaps a combination of the two.

3. Balance sheet

Your balance sheet shows your assets in conjunction with your liabilities, giving you an overall financial snapshot of your business equity within a specific time period.

If your assets exceed liabilities, your equity will be in the positive (this is what you want). If the latter occurs, your balance sheet equity will be in the negative.

Balance sheets are very helpful in understanding the financial overview of your company over time.  By comparing your balance sheets month to month, and year to year, you will get a solid idea as to whether your company is:

  • Experiencing satisfactory growth;
  • Increasing in value over time; or
  • Seeing a decrease in liabilities.

Plus, it will help you forecast months and years to come.

Using the profit information from your income statement, you can also create a strategic plan for how to pay off liabilities, and invest in assets if and when appropriate.

Proper planning is crucial for any new entrepreneur’s success. Regular reviews of how financial resources flow through your company will help you plan for growth. Of course, nothing is certain, but armed with this basic knowledge, you have a foundation from which a strategic plan can drive your new business forward.

NOW READ: Is your co-founder your best friend? Here’s how to ensure your business and friendship flourish

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Daniel Smith

Daniel is the founder of insightfactory.net.au.

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