Introduction to Financials – Where Am I and Where Am I Going?

As a business owner, you are the captain of your ship or the pilot of your plane. Are you aware of where you are and where you are going? Your family, employees, customers, suppliers, and bankers are relying upon your piloting skills.

Imagine that you are walking into a commercial aircraft to fly to Denver. As you walk past the open cockpit door you see the captain standing at the entrance, leaning toward the instrument panel. To your surprise you hear him exclaim: “Look at all of these lights and dials! I wonder what they all mean!” Would you continue to your seat?
Are you a skilled pilot of your business?

How many business owners are looking at their navigation and control panel – their financials – and thinking: “I wonder what all of these numbers mean?” Would you agree with me that if someone chose to fly a plane without understanding the cockpit instrumentation that they might be able to fly a couple times if they were lucky, but that it would be just a matter of time before they die? Is it any wonder that 85% of the businesses that start today will not be in business 5 years from now?

Business or entrepreneurship is an intellectual sport! Financials are the scorecards. Anyone who chooses to play based on their GUT (Gave Up Thinking), sooner or later will crash and burn. It’s just a matter of time. They are operating on Hopium!

Three vital flight instruments

There are 3 critical dials in the business cockpit that comprise what we call “financials.”

The first is called a Balance Sheet. This is analogous to the Heading Indicator, also known as the directional gyro, or DG. More advanced aircraft use the Horizontal Situation Indicator. These instruments display the aircraft’s heading with respect to geographical north. The balance sheet displays the company’s heading. It is a snapshot in time as of the date that it is generated. It can also be viewed as a world atlas, providing high level company health information for determining if the company is improving or deteriorating.

Every single financial occurrence in the business affects the balance sheet. However, looking at a balance sheet doesn’t give you all of the information needed to fly the plane or guide your business. Looking at a balance sheet is like viewing the last scene of a movie. For example, it tells you how much cash or retained earnings you have, but doesn’t tell you how you got there.

That is why an Income Statement (IS) and Cash Flow Statement (CFS) are vital instruments in your cockpit. I like to compare the Income Statement to the Airspeed Indicator. By recording your airspeed during the entire journey, you have a history of how efficiently you controlled your plane and fuel usage to arrive at your destination. The Cash Flow Statement is analogous to the cockpit altimeter. This shows how much altitude you have before you either land safely or crash and burn. If we run out of cash to run our business, it’s like prematurely running out of altitude to fly our plane. We die!

While the Balance Sheet is a snapshot in time, the Income Statement (Profit and Loss Statement or Operating Statement) and Cash Flow Statement are like motion pictures, rather than a snapshot. They give us a record of events happening over a period of time; events like buying inventory, making your product, selling it, and incurring expenses in the process. Just like a movie, the IS and CFS provide us with a financial scorecard that shows motion over a period of time. They have a beginning and end, just like a movie.

Income Statement records cost control

The IS tells us how efficient we are at turning revenue (sales) into profit, i.e. controlling expenses.Many view this report as the most important and ignore the others to their peril. Typically when handed financials we first look at the IS bottom line, which is net profit or earnings. If it looks good; we have a drink. If it looks bad; we have a drink! The truth is: the IS is a theory! Have you ever tried to spend profits? Try telling the grocery clerk that you would like to use the profits from your business to pay for groceries! The only real spendable produced by a business is cash. Have you ever reached the end of a profitable month and wondered where the cash went?

All transactions come in two parts:

1. The Promise (to deliver something of value to the customer with the customer agreeing to pay a certain amount for that value)

2. The Settlement (delivery of the value to the customer and payment)

I can’t spend profits

The IS records the promise. The CFS records the settlement. Net profit is a record of the Promise. I can’t spend a promise; I can only spend cash – the Settlement. I can be profitable but run out of cash (altitude) and I die. In fact, like an F-16, speed kills! If I’m not well trained and skilled at reading all of the dials, the faster I go (net profit) the faster I can run out of cash (altitude) and I die! Growing too fast can be just as dangerous as not fast enough. That is why Cash Flow Statements are so vital to avoiding a crash, and, unfortunately, the most neglected dial by many business owners.

Financial Statements enable control

Financial statements give us levers so that we can steer the plane rather than just be blown around. They help us be more effective (doing the right things) and efficient (doing the right things right). “If you can’t read the scoreboard, you don’t know the score and can’t determine winners from losers!” – Warren Buffet