How to Understand Your Books and Confidently Make Big Business Decisions

In my April article, I talked about the high-level category structure used in accounting. It’s a solid intro. But it doesn’t get into understanding the financial health of your business. The definition of health is inconsistent and highly dependent on contextual factors. It’s dangerous to oversimplify into a simple dichotomy of “healthy” or “not healthy.” 

The question of business health also can’t be narrowed down to a single datapoint. It can be tempting to ask your accountant and have them tell you if your business is healthy or not. Or to look at a balance in your bank account to determine if your business is healthy. Both of these approaches have blind spots. They are one datapoint at one moment in time. If your meeting was many weeks ago or an autopayment hasn’t gone through, that information isn’t complete. 

My dream for my clients is that they understand the financial health of their business well enough that they can make big decisions with clear data. Sometimes these big decisions sneak up on you. What if the office/retail space of your dreams becomes available... Is your business doing well enough to take the leap into renting this space? You could make the leap on a single data point, but you don’t have to. Your accountant might yay or nay it, but you deserve to understand how they got to that answer. 

3 Key Data Points

Big business decisions have two facets: the present and the future. Today we’re going to talk only about the present. It’s based on straightforward numbers and an absence of any conjecture. In subsequent articles, I’ll discuss trends and forecasts that also help you understand the health of your business. For now, we’ll consider liquidity, outstanding transactions, and profit. 

Cash in the Bank (Liquidity) 

For those who read my last article, you can calculate liquidity by dividing your assets by your liabilities. Most of us here didn’t take out business loans, which means our liabilities are small to non-existent. This makes the math super simple! We just need to know there’s cash in the bank.

Get this data! How? login and check your bank balance.

Outstanding Transactions

The cash in your bank account isn't the whole picture. We need to take into account money that’s in transit, aka unpaid invoices (Accounts Receivable), and bills that are coming due (Accounts Payable). For example, if you received a massive deposit for work you're doing over the next year, that’s income that needs to last. Similarly, if I pay for my CRM on an annual basis and it’s about $1,200 per year, I need to know if it’s right before that renews. Your accounting system and the reports it generates can help you know what you need to factor in. 

Get this data! How? check out your invoicing and/or bookkeeping system to make sure your clients are all paid up and your bills are all paid. 

Profit

A business is often considered healthy if it is profitable. But what it means to be “profitable” is confusing for many self-employed business owners. It's easy for an accounting system to generate a Profit and Loss (P&L) Report. This report tells you if the business is turning a profit, but it's likely muddying the water between your pay and profit.

For single-owner LLCs and sole proprietorships, the final line of your P&L Report combines your owner pay with true profit. Owner pay is the money you earn for the work you do. Profit is what you, the business owner, get if the risk of starting a business pays off. It all goes to the same place (your pocket), but it has different significance. The only exception to this is if you run payroll for yourself, since payroll appears as an expense on a P&L Report. But you wouldn’t run payroll for yourself unless you’re an LLC filing as an S-corp.

If your P&L Report shows a loss, your business isn’t doing its best. However, a profit needs to have your owner pay expectations taken into account. For self-employed businesses, we need to plan for profit. We need to build it into our financial plan. Profit is not something that “pays off” somehow at the end of your business. You don't want your business to end, so pay yourself profit along the way! Learn more about how to do this in my article End Financial Overwhelm: Reliable Results Just Need 3 Things to Balance.

Get this data! How? First, have your bookkeeping system generate a P&L Report for you. Then compare that number at the bottom with your pay expectation and how much is left over from that (e.g. true profit)

Finger on the Pulse of Your Business  

These three key data points will tell you a lot about the present health of your business. If you’re liquid, profitable, and you’ve taken outstanding transactions into account, then you’ve got some sure footing. These data points don’t take forecasts for the future into account. Especially when you’re considering making a change, you need to forecast the impact of the change. But we’ll get more into that in future articles. 

Did you notice that these data points depend on your bookkeeping and P&L report? If you haven’t tackled this aspect of business yet, I’ve got support for you! Bookkeeping isn’t complicated, and I have how-to instructions available in The Launch Pad. There you’ll also find recommendations on accounting software and finding professionals who can help you. And as always, for individualized support, don’t hesitate to reach out!