Let me start by saying I hate accounting.
But I am excited to begin sharing with you about my budding love affair with the very thing. It began last week, with a book by Leita Hart called Accounting Demystified (especially the first 4-5 chapters).
As a creative type, my brain just isn’t drawn to financial stuff. When the talk of debits and credits gets too deep, I just gloss over and think about DSLR’s and should I get the new Macbook Pro or wait for the next one?
But Leita does a fantastic job of beautifying all the gory details of accounting and speaking in terms you and I can understand.
Here is my summary. But don’t take my word for it, read her book!
Accounting is just financial story telling (hopefully non-fiction stories!)
- Accounting is a big database of transactions. That database is called a general ledger.
- The data in this database can be presented in many ways and can tell many different STORIES about the business.
- This notion of the data telling stories about the business really triggered some ideas for me regarding how we grow Blinksale. Hint: It is not about reports, spreadsheets, credits and debits—it’s about stories! All the statements pull together to tell a story about the business and each story is unique.
- The primary 3 stories that come out of the database are summaries of the financial data from 3 different perspectives: the balance sheet (the super summary) and two “drill down” perspectives, the income statement (sometimes called a P&L or profit and loss statement), and the cash flow statement.
- When combined, these stories tell the business owner a few key things: how flexible or liquid is the organization, how profitable is the organization, is it growing (or have growth potential), and how is the business financed?
The balance sheet:
- The balance sheet is the “master story” that sits above the other stories.
- It could be considered “my business summary”. It tells the story of the assets of the business, the liabilities of the business, and the equity (or lack thereof) that the business has developed over time.
- The formula for this story is assets = liabilities + equity.
- The items on the left MUST add up to the items on the right because of this basic formula.
- Assets are always shown on the left and liabilities and equity are always shown on the right. For example, if you have $100,000 in cash (an asset), and you owe someone $50,000 (a liability), that means you have $50,000 in equity. It is that simple!
- The balance sheet tells three critical stories: 1) who owns the business, 2) how lean and mean the organization is running, and 3) how “liquid” the organization is (hint: liquid = good).
The income statement:
- The income statement or P&L tells the story of profit (or loss!). It’s focus is on revenues, expenses, and the profit or loss that is generated from them.
- Revenues minus expenses = profit. Hint, this is really important!
- Some costs are fixed, like rent. Some are variable like dining and entertainment or advertising.
- The income statement tells the story of profitability.
The cash flow statement:
- The cash flow statement is like your bank statement and is focused on cash—specifically how much you started with each month and how much you ended with.
- This is not the same as the income statement. In most businesses, the profit or loss for the month won’t be the same as the ending cash for the month. Don’t get this confused with the income statement.
- One key story the cash flow statement tells is HOW the company is generating cash. For example, Blinksale generates cash via subscriptions (good), and through the occasional outside investment (not as good). Each impacts cash. The one that is the most valuable to us, because it means we are healthy and doing our jobs well is the part of the cash flow that comes from NET INCOME (via subscriptions). The part we want to keep reduced (or eliminated) is cash inflows via investment, because that means we either owe someone money or are giving away stock in our business.
- THE key question the cash flow statement answers is this: “Is the net income (as seen on the income statement) ever realized in cash?” For example, if Blinksale had $100k in revenue, and $50k in expenses, we SHOULD see an increase in cash of $50k. If we don’t, it may not mean bad news, but could mean that there are other factors impacting cash that could use our attention.
How are the three reports (stories!) related? How do they tie together?
- Remember, the balance sheet is at the top.
- The income statement is the DETAIL of how earnings (profits or losses) were generated (remember: Revenue minus expenses = profit) Each month’s total profit or loss is added to what is called “RETAINED EARNINGS” on the balance sheet. So if you “drill down” on retained earnings, you would hit the income statement and see the detail of what happened.
- The cash flow statement shows you what happened to cash. It is the DETAIL of the item on the balance sheet called cash.
What does this all this mean for Blinksale and for you? Well, hopefully some of it will help you better understand some of the basics of the numbers that impact your business every day.
And after reading the book, and lying awake excited about all this financial storytelling stuff, I decided to ping the book’s author, Leita Hall and ask if we could meet to do some product brainstorming. Thankfully she obliged, and so late last week, in the midst of all the SXSW partying, we sat in a conference room in an Austin hotel and talked about financial storytelling for an afternoon.
Needless to say, we’re pretty excited about the idea of having some form of financial storytelling built into future versions Blinksale.
Have any thoughts on the matter? Let’s hear em!