Money Talks: Three Most Important Scorecards of your Business
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Kudos to Keith Cunningham, the author of his new book ‘Keys to the Vault’, I had the opportunity to learn from this man the past weekend and it was absolutely amazing. I have never seen (or heard) finance being explained in such simple terms and so easy to understand. I want to take this opportunity to say ‘Thank you’ to Keith and also share this invaluable financial literacy lesson with our youngster community.
The three most important scorecards of any businesses are:
- Balance Sheet
- Income Statement
- Cash Flow Statement
First of all, let’s discuss why we need to understand these score cards. Running a business is just like playing a basketball game. Without keeping track of the score, you would have no idea if you are doing well or not doing well. The Balance Sheet is just like a picture of your game, you can see your performance at a particular point of time (e.g. half time). Balance sheet is great but you would have no idea what you need to improve from just a snapshot. So what do you need instead? A movie! The Income statement and cash flow statement. These statements are the replay of your game. By looking at these movies, you can tell exactly where you need to improve to play a better game.
Balance Sheet
Balance sheet has of 3 major components:
1) Asset – This section lists out all the cash, inventory, real estate, account receivable or machine that your business own.
2) Liability – This section lists out everything you owe including account payable, debts and tax dues.
3) Equity – This section lists out everything you own including stock, earnings, etc.
Regardless of which format of the balance sheet you are looking at, the following equation will always be true:
Asset = Liability + Equity
Income Statement
Income statement composes of 3 major numbers:
1) Revenue
2) Expense
3) Net Income (profit)
Imagine you see the magic number ‘profit’ of $100 in your income statement. What does it mean? Well, before you go celebrate, can you tell the difference between the 2 scenarios below?
Scenario One
I sell bicycles and here is my performance this past month:
Sold 10 Bikes (Revenue): $1000
Cost for 10 Bikes (Expense): $900
Profit: $100
Scenario Two
I sell bicycles and here is my performance this past month:
Sold 2 Bikes (Revenue): $200
Cost for 2 Bikes (Expense): $100
Profit: $100
The $100 of profit mean very different thing in Scenario one & two. I would rather invest in Scenario two because if I spend $100 I can make a $100 back in profit versus in Scenario one if I invest $900 I can make only $100.
Cash Flow Statement
A cash flow statement would look at like:
Beginning Cash
- Operating Income
- Investing Income
- Financing Income
= Ending Cash
The most important number in the cash flow statement is the ‘Operating Income’ it does not matter how much you invest or borrow, you need to make sure you can survive with enough operating income to continue your business.
Imagine you just sold 2 bikes for $200, but your customers told you I can only pay you 6 months from now. Assuming you have no additional cash you can borrow or invest to make another bike, this would mean you will be out of business immediately unless your customers can pay you right away. Cash flow statement is that movie which you can play to tell exactly how good of a game you are really playing.
Today we discussed three scorecards and they are:
- Balance Sheet
- Income Statement
- Cash Flow Statement
If you want to learn more, I will suggest checking Keith’s new book ‘Keys to the Vault’.
Have fun with your score card.
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Money Talks for the Young Entrepreneurs
What We Cannot Learn from School