As the name implies, this is simply a report that projects the cash you are anticipating to come into, and flow out of, your company in the future months. It won’t predict the future for you, but it will help you to plan and develop the strategies necessary to keep your business running smoothly

A cash flow projection begins with looking at your current cash position: cash on hand, accounts receivable and accounts payable. The next step is to develop a projected timeline for the collection of those receivables and payment of the payables. This is the most basic form of a cash flow projection. However, it doesn’t let you look very far into the future. To do that, you need to go on to the next step.

The next step is to add ‘anticipated’ cash flow projections into your timeline. Based off of your current sales and anticipated future sales, add in amounts that you expect to be depositing in the future and correlating expenses. These projections should be on the conservative side, not from the ‘best-case scenario’ view. You don’t want to fool yourself by being overly optimistic. Make sure you don’t overlook things like your annual insurance audit, employee pay increases or bonuses and other expenses that aren’t a part of your regular monthly routine.

Mapping these numbers out on a timeline that shows the expected hills and valleys of your cash flow for the next 6 months can help you develop advertising and promotional strategies. It can also prevent you from spending too much during a peak in cash flow since you will have the anticipated valleys clearly mapped out before you.

Don’t let the highs and lows of your cash flow take you by surprise. Take the time to develop a cash flow report to help you peer into the future. We’d be happy to help you lay out the numbers and learn how to read the map.

To understand where to record your debit entry for a purchase, lets look at some definitions.

• Fixed Assets – Personal or real property which will have a use-life of more than one year.

• Operating Expenses – General expenses related to the cost of doing business.

Now, let’s look at a purchase scenario.

Company A has just purchased a new desktop computer for one of its salesmen. The purchase included a computer, monitor, printer and ink for the printer. How should this purchase be recorded?

The computer, monitor and printer are all personal property items that have a use-life of more than one year. These fit into the definition of a fixed asset and should be recorded under a fixed asset account that contains your office furniture and equipment. Any shipping costs or taxes related to the purchases of these items should be included as part of the transaction entry into the asset account.

The ink for the printer, however, is an expendable operating EXPENSE. The cost of the ink, including and shipping and tax, should be recorded in your office supplies expense account.

But the computer and printer cost you money, how do I deduct those costs off my profit? The costs of your assets are deducted from your profit each year through depreciation expense, which is also located on the income statement under your operational expense accounts. At the end of each year, your accountant will determine the percentage of the value of your assets that can be recorded as depreciation expense and deducted from your profit.

The dollar amount of depreciation Company A will be allowed to deduct for this equipment purchase will depend on what time of the year the pieces of equipment were purchased and the depreciation schedule over which the value of the item is depreciated.

This is a basic organizational layout of any chart of accounts, and the types of items entered under each category:

Balance Sheet Accounts:

Assets

• Current Assets -Cash accounts, Accounts Receivable and Inventory
• Fixed Assets – Items that will depreciated over a period of years. Vehicles, furniture, equipment, buildings and real estate.

Liabilities

• Current Liabilities – Accounts payable and any portions of debt that will be paid within the current year.
• Long term Liabilities – Mortgages and other long term debts.

Owner’s Equity

• Owner’s Contributions – Initial startup costs and other contributions
• Retained Earnings – Accumulated profits and/or losses

Income Statement Accounts:

Operating Revenue – Gross sales

• Cost of Goods Sold – Direct costs of sales: purchases, labor for services, materials, subcontracted labor

Operating Expenses – Administrative salaries, office expense, rent, utilities, insurance etc
Non-operating Revenue – Sales of assets, refunds
Non-operating Expenses – Penalties, fines etc.

This, of course, is still a very broad overview. Be watching for more detailed explanations of these accounts in our future blog posts.

Select your Quickbooks report, your profit and loss by class would be a good choice. If you need to make any changes to the data, such as setting a filter or customizing the dates, do that first. Then, instead of printing or saving the report, select Export to Excel and send the report to a new Excel workbook.

Excel will open with the Quickbooks report laid out on the first worksheet. Now, all you have to do is use Excel’s formatting tools to add color and borders to your headings. Bolding your fonts will make your header titles stand out and easy to read. Change column widths or insert columns to provide more space between the columns of data.

Select preview, to see if you need to do any fine tuning to your sexy looking profit and loss report, before you print it out in full color. You’ll be amazed at how much more professional those reports can look and how much easier they are to read.

Color coded headings can be a great way to distinguish reports for different departments, different financial periods (months or quarters) or to distinguish the monthly P&L from the year to date P&L for the same period.

Color, bolding, increasing font size, all these formatting options can be used multiple ways to highlight totals or any other aspect of a report that you want to stand out.

Once you have your formatting scheme setup for each report, you can easily apply it the new report for the following month by using Excel’s format painter to copy last month’s formatting onto the new month’s exported report. It’s quick and easy.

In addition to the formatting, exporting a report to Excel will also allow you to add notes to a report. This can be especially useful on budget reports to note reasons for over budget items or highlight budgets that may need to be adjusted.

Why stick with boring black and white, when you could dress up your financial reports sexy reds, blues and greens?

In the straight line method, you depreciate the asset by the same amount over the life of the asset. So let’s say that you buy a piece of equipment for $10,000 and you reduce it by $1000 per year over 10 years. In the first year it’s worth $10,000; in the second year it’s worth $9,000, in the third year it’s worth $8,000, and so on.

In the “reducing balance” method, you deprecate the asset by a fixed percentage every year. Let’s say that you buy a piece of equipment for $10,000 and you reduce it by 10% per year. In the first year it’s worth $10,000. Then you reduce it by 10% ($1,000) and it’s worth $9,000 in the second year. Then you reduce that number by 10% ($990) and the asset is now worth $8,010. Then the next year, you reduce that number by 10% ($801) so the asset is now worth $7,299.

In the first method, the number reduces consistently over time; in the second method, the number reduces dramatically in the beginning but there is less depreciation over time.

So which should you choose? Whichever method you choose, you need to stick with it.

The “straight line” method is useful for situations where the asset will provide a consistent benefit over its lifetime. The theory is that you’ll match the consistent depreciation with a consistent earning of revenue.

The “reducing balance” method is useful for situations where the asset will provide more benefit up-front than later. Some equipment that might, over time, become less efficient or less useful might be better to depreciate at a greater rate up-front since you are also getting a larger economic advantage up-front.

Talk to your accountant about which depreciation method you should use.

In spite of your best efforts, these receivables end up getting older and older and you realize that you will never collect from them. Everyday people might call this “hopeless” but in accounting lingo, it’s called “bad debt“.

It’s tempting to just ignore your bad debt. (Hey, no business owner wants to be reminded of a customer who pulled a fast one on them). Unfortunately, doing that will artificially inflate the assets on your balance sheet while also misstating your profit.

But you do need to do something with these numbers! Here’s what to do:

1.   On the asset side of your balance sheet, reduce your accounts receivable by the amount of the bad debt.

“But something’s not right!” you say. “The two sides of the balance sheet are supposed to be equal! If I reduce my assets by the amount of the bad debt, they won’t be equal anymore!”

Good point! So here’s the other thing you need to do:

2.   In your income statement, add a bad debt expense (just make sure that you add it into the same time period that the sale was made).

Here’s what happens as a result: The profit in your income statement will be reduced by the amount of the bad debt and it will be reflected back into your balance sheet.

Here’s a simple example to illustrate:

Mary’s company has a balance sheet that looks like this:

Assets
Stock: $50
Receivables: $20
Cash: $10
TOTAL: $80

Liabilities
Loan: $20
Payables: $40
Capital: $20
TOTAL: $80

If Mary has a $5 bad debt, here’s what she will do:

• First, she will reduce the receivables in the assets column of her balance sheet by $5.

• Second, she will add an expense of $5 in her income statement, which will reduce her profit by $5.

• Third, she will go back to her balance sheet, this time to the liabilities column of her balance sheet (where profit is part of capital), and she will reduce that by $5.

Bad debt is no fun and there are many things you can do to avoid it. However, if you do get it (and you probably will at some point), this is how you make the adjustment in your financial statements.

I am going to try to make it simple (and I hope I’m able to do so!)

First let me refresh your memory on the difference between cash and accrual accounting.

If you are in the US, you have to pick a standard by which you do your books. Most small businesses report their Income and Expenses to the IRS on a Cash basis, but a cash basis is not always the best for internal reporting and figures.

Here’s a brief explanation of Cash Basis accounting: Money is earned when it is received, not billed. Expenses are classified as expenses when they are paid out, not when the invoice is received.

So, in other words you send an invoice to ABC, Inc. in November and they pay you in February. It is income in February not November.
Or you get a bill from the phone company in January and you pay it in March, it is an expense in March, not January.

Having your IRS reported basis as Cash is comfortable for many businesses and you assure you only pay taxes on what you actually ‘receive’.

However, in daily business operations, it is not the best way to go. I mean, think about it: If you created a website for a client, let’s call him John, and you bill him the $1,000.00 in January once the website is done, but he does not pay until February. Then the graphic designer you had working on John’s design cost you $400, but he billed you in February, but you don’t pay him until March.

If you use Cash Reporting it looks like this:

This is of course pretending those were your only business income and expenses. However, you see the issue. January has nothing, when it should have $1,000.00 income, $400.00 Cost of Goods Sold and $600.00 profit. Whereas February and March have figures that should not exist.

In the grand scheme of things your Net is still right, but it does not help you for monthly planning and budgeting.

Now, using a robust accounting system such as QuickBooks can rectify this situation because you can enter everything accordingly and change your report type from ‘cash’ to ‘accrual’ and back to ‘cash’ as needed.

However, there are plenty of things you need to be aware of in order for the system to report correctly.

1. Make sure you enter an invoice. Don’t just enter a direct income when the monies are received. Make sure you enter an invoice with a date in the month that the actual sale transpired.

2. When you receive monies up front, such as a deposit, don’t enter those as an income, because they are not. These are monies held in trust. Create a liability account called “Deposits on File” or “Monies in Trust” and record the deposits there. This will let you have it in your books (i.e. in your bank account) but clearly show that it is not earned yet; it is a liability (meaning you owe this value of money or services to someone).  Once you do invoice them, you can apply these monies.

3. When you pay for something in advance, don’t just enter it in one lump payment. For example, let’s say you paid $12,000.00 in rent for $1,000.00 a month for 12 months. Don’t enter it all in January as rent, because then you have overstated expenses for January. Set up an asset account called Prepaid Rents, and every month transfer $1,000.00 out of the asset account and put it in the rent account. This way you can document that the $12,000.00 went out of your bank account and into another “asset”, but it was not actually an expense of $12,000; rather it was $1,000 a month for 12 months.

4. When you get a bill, don’t put it in a box and wait for it to be paid. Enter the bill as an accounts payable using the date the bill was generated (or better yet, service performed). That way you have it on the books in accrual format and it is there to mark “paid” once you actually do part with the cash.

Performing your bookkeeping this way will assure the following:

1. You never over-report your income or expenses to the taxing authority when reporting in cash basis and you will pay the proper taxes.
2. You will always have clear financial statements by month, showing the real income and costs per month when reporting in accrual format.
3. A quick look at your books and you will always know what you have or what is coming (assets) and what you owe (liabilities).

I’m realistic enough to realize that financial statements can seem complex and unwieldy at the best of times, which I’ve been walking you slowly through the details that I felt you needed to know. And I was planning to show you how to build the three spreadsheets yourself. But I’ve got good news for you: In the last blog post of this series, I’m going to make it really easy for you! I’m going to link you to one free file that you can download that will GIVE you all three spreadsheets in a single Excel file. Here’s how to get it and use it:

Step 1: Download the Consolidated Report Template from the Microsoft Office site in the template section.

Step 2: Unzip it and open it. (You need to have Microsoft Excel 2003 or later).

Step 3: Start using it! It’s divided up by months and all three of the statements are conveniently located on one sheet. It’s already formatted and encoded for you! By entering a number into a cell, you’ll notice that many of the other numbers are impacted by the cell’s information. Simply zero out all of the numbers, fill in your own details, and watch your balance sheet, income statement, and cash flow statement auto-fill as you go.

Financial spreadsheets are powerful and should be used by your business. They can guide you to make better decisions and understand your business deeply. Unfortunately, business owners fail to take the time to understand their spreadsheets so these spreadsheets end up diminishing in usefulness. Use your spreadsheets, put them to work for you and your business will run better because of it!

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.

If your small and growing business doesn’t have an accountant yet, or if you want to make it really fast for your accountant to get through your records and start delivering the meaningful insight that you are hiring them to provide, you need to build and implement a spreadsheet-based accounting system as early as possible.

Here’s how to do that:

Step 1: Open your favorite spreadsheet.
You should use something that most accountants will use (so that when you pass your work to them, they can access it easily). So consider Microsoft Excel or Google Spreadsheets.

Step 2: Create 3 sheets.
Within each spreadsheet file, down near the bottom of the screen, is a place to create sheets. You’ll want to have 3 and you should rename the sheets to read: “cash flow statement”, “income statement”, and “balance sheet”.

Step 3: Format each sheet.
The cash flow statement measures the flow of money into and out of your business over a period. So, you’ll want to format your sheet so that you measure the period across the top (weekly or monthly, depending on how much cash flow you have), and then the following labels in the rows below:

• Opening balance
• Cash from sales
• Cash paid out
• Closing balance

The income statement, also known as your “profit and loss” statement gives you a snapshot of your business’ profitability over a particular period. So, make sure you include the period at the top of the sheet and then put the following labels in the rows below:

• Sales
• Cost of sales
• Gross profit
• Expenses (which you’ll want to itemize individually, including wages, rent, utilities, etc.)
• Net profit

The balance sheet gives a snapshot of the accumulated success of the business in a given period. So, make sure that the period is listed across the top of the sheet and then put in the following labels in rows below:

• Assets (itemize these as cash, physical assets, receivables, stock)
• Liabilities (itemize these as capital, loans, and payables).

The basic spreadsheet is set up. The important thing to remember is this: On their own, spreadsheets don’t really matter. They are a means to two ends:

1.    Providing valuable records so that your bookkeeper, accountant, stockholders, and IRS (if they ever audit you) have all the information they need at their fingertips.
2.    Providing you with real insight into your business so you can make better business decisions.

In an upcoming blog I’ll show you how to put your spreadsheets together so they are automated and useful for you!