Demystifying Financial Reports

04 April 2015
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Categories: Dollars & Sense

Not long ago I was looking at some x-rays, and was trying to make sense of what I was looking at.  To me, I was just looking at picture of my skeleton.  But to the technician I was with, there was a story that was being told—one of trauma that was in process of healing.  And, once they showed me what to look for on that x-ray, I understood what was going on too.

The reason I share this is because it reminds me of what I often experience when talking to business owners about their financial reports: once they know what to look for, they see and understand what the numbers are telling them about their business.  But at first glance, it looks complicated, and I think for two reasons.  The first reason is that there are a lot of reports that QuickBooks desktop version offers.  There are more than 150 reports that QuickBooks generates, and that’s before getting into the tweaks and modifications that one can make to them.  Second, I think it looks complicated because of unfamiliarity with the reports themselves—unfamiliar with the layout and the intent of the report.

What I’d like to do in this post is to give clarity and demystify financial reports.  We’ll do this by looking at the different reports and see if we can winnow down which ones to look at since 150 reports seems overwhelming and could lead to information overload.  And as we review the essential reports, we’ll also think about information should be highlighted as we review them.

Core Reports
The first core report is the Balance Sheet, which at the highest level, is the net worth statement for the business.  When reviewing it, the focus is on working capital, which is calculated as:

  • how much money we have in the bank,
  • plus how much money we’re expecting soon from customer payments (receivables),
  • minus how much money we need to pay out in the near future (particularly bills recorded in accounts payable, credit card balances, short-term loans, and tax obligations).

This means that there is a lot that can be ignored on the balance sheet: fixed assets, depreciation, amortization, and long term obligations.  While I don’t want to get technical here, I think it merits explanation why.  It’s not that these aren’t important, but because they don’t have much bearing on near-term decisions in the business.  Think of it this way: when it comes to the managing the family finances and figuring out how much you can spend on your next vacation, we check our bank accounts, money market mutual fund balances, and credit cards to see what’s available, and not raid the retirement fund or sell the car or house to go on that vacation!

The second core report is the Profit & Loss Statement, which is quite straightforward: the more money at the very bottom, the better!  That said, I find that businesses benefit by following several principles with this report.

  • First, it helps when we keep cost of goods sold (expenses that are incurred to make income (such as inventory or contractors you hire to support a special project) separate from regularly recurring overhead. This will make it easier to see what the “monthly nut” is that needs to be regularly met, versus the costs that increase or decrease depending on how much you’re selling.
  • Second, it helps to keep tax-related items out of overhead too. I would include in this both the taxes themselves, and depreciation, amortization which primarily tax accountants are concerned with.  It’s not that these aren’t important, but how often do we include depreciation as part of making a business decision?  Probably not very often.
  • Finally, the way the Profit & Loss Statement is organized can help clarify and make meaningful the information. Using account numbers to sort the report with key figures toward the top, keeping the report to no more than two pages, and using subaccounts are common techniques for having a clear, meaningful layout for this report.

Additional Reports
In addition to the Balance Sheet and the Profit & Loss Statement, QuickBooks offers a lot of other reports.  To make it easy, we can break those down into three categories: reports that supplement these two reports, management reports to help manage the business, and information reports.

Supplemental reports provide greater detail and insight into the Balance Sheet and the Profit & Loss Statement.  For example, I might be meeting with a client and point out that accounts receivable seems high, so we’ll look at an Accounts Receivable Summary report to get a list of which clients owe them money and how old those receivables are, because we want to make sure that there aren’t going to be collection problems.  Or perhaps we’ll notice that income is doing well, and so we want to understand what is working right.  So we’ll look at Sales by Item and Sales by Customer reports to find out if there is a product that is doing well or a client that has been buying more.

While the core reports give an overview, and supplemental reports provide supporting detail, the core purpose of management reports allow us to manage the business, and especially to make it easier to manage the business.  A collections report gives a customer name, contact information, and list of outstanding invoices to make it easier to contact them and collect money.   Likewise, the time management reports help us manage staff and client services to see what work has been done and how much time has been spent by my people on different clients.

Information reports provide lists or other information to help manage the business.  Being able to print a customer contact list or vendor contact list can be helpful for non-financial staff.  Sometimes I’ll find that my task management system has too much detail, and I’ll go back to QuickBooks and print my list of clients to take a high level view of where each is at.

As incredible as it may sound, this is really the essence of financial reporting: run a Balance Sheet, run a Profit & Loss Statement, run supplemental reports to round out the picture, and that will give a fairly complete picture of where a business is at and how it is doing.

As I wrap up here, I’m asking myself how to make it most beneficial for you, my entrepreneurial reader… First, I suggest that you go into the QuickBooks reports menu, find the Balance Sheet and Profit & Loss Statement reports, and look at them.   Go ahead and print them, and then start marking them up.  For the Balance Sheet, circle the bank balances, accounts receivable, and the short-term liabilities (credit card, accounts payable, and taxes), then do the math: bank + receivables – liabilities = working capital.  Likewise, on the Profit and Loss statement, just look at the bottom.  Is it what you want to see?  And finally, start looking through the different report titles and seeing if there are reports that might supplement information that you’ll need to look at.