Transform Your Business With Spreadsheet Accounting – Part 2

In a previous blog post I showed you a way to put together a single file consisting of your three most important financial reports – the reports that every business should have.

I’ll be talking to you over the next couple of blog posts about these spreadsheets and how to put them together but in this post I want to pause momentarily to talk to you about the all-important question of WHY.

Why do we need those three financial reports? When we answer that question, understanding HOW the spreadsheets work falls naturally into place.

There is a relationship between the three financial statements – the cash flow statement, the income statement, and the balance sheet – that will help you to understand how they work together:

The three financial reports and how they work together – two analogies

I want you to think of a simple wooden fence you might see if you were to drive through the countryside. There are posts stuck into the ground every few feet and there are two boards of wood placed horizontally, connecting each post. If that fence were a timeline, instead of a way to keep cows from going into a neighboring field, you can think of the posts in the ground as the balance sheets and the two horizontal boards as the income statement and the cash flow statement. Each cash flow statement and income statement connect one balance sheet to the next.

Here’s another way to think of these statements: Imagine that you could somehow capture your business’ financial information visually. The balance sheet is a photograph of an exact time period of the business while the cash flow statement and the income statement are film strips that show you motion and change. So, with these photographs and filmstrips, you would lay them out like this:

The balance sheet photographs would be spaced at regular intervals, like fence posts. Let’s say that you have one balance sheet photograph for each week and over the course of the year you collect 52 balance sheets and space them out evenly. But those photographs only show you what the business is like at that exact moment that the photograph was taken. You’d like to know how the business got to that point.

So, you have film strips that show you how things change over time. The cash flow statement shows you how cash came in and went out. The income statement shows you expenses and income and the resulting profit. Each cash flow statement filmstrip and income statement filmstrip connects one balance sheet photograph to another, very much like the horizontal boards on a fence.

Here’s an example: If you had a photograph of a caterpillar, a photograph of a cocoon and a photograph of a butterfly, each of those would be interesting and useful but they would be even more useful if you also had a filmstrip showing how the caterpillar wove the cocoon and then another filmstrip showing how the butterfly emerged from the cocoon. The photographs could be placed at intervals and the filmstrips of the actual change would connect them.

Moving forward with your three financial statements in place
Now that you know the relationship of the three financial statements, it’s easy to see why you need them: On their own, none of them give a complete picture of the business. But taken together, they do give you a complete picture of the business.

So, what does it mean for you? Overall, it means that making decisions for your business based on a single financial report is dangerous. You need to take all of the measures of your business into consideration. The best thing you can possibly do for your business and its health is to understand the 3 financial reports and learn what they mean for you. Even if you get an accountant to do your finances, this should be at the top of your “need to do” list.

And here’s what this means as you put together spreadsheets for your financial reports:

• As you develop the spreadsheets I mentioned in the last blog post and will mention again in an upcoming blog post, you need to choose periods of time that make sense for you. If you have a lot of transactions, you might want to choose daily “photographs and filmstrips”. Or perhaps weekly. Or perhaps monthly. You need to find the balance between a comprehensive view of your business and a realistic amount of work inputting and reading and thinking about the information.

• There needs to be agreement between each statement. You’ll notice that some of the elements from one statement will appear in a different statement. These aren’t three separately occurring statements. They are interrelated.

Financial statements are frequently put together as an afterthought – something people do because they have to do it. But financial statements are extremely useful for your business and in the next few blog posts you’ll see what you can do with these spreadsheets using something as simple as Microsoft Excel to have a meaningful impact on your business.