Understanding Financial Statements part 1
Measure Your Growth in Real Numbers
As an entrepreneur, you won't know whether your business venture is economically feasible without a good understanding of financial statements. That's because your financial statements allow you to forecast your business venture's profits, its asset and financing requirements, and its cash flow-all critical elements in determining the profitability of your business. In the video segment, you'll meet Jim Schell, business owner, author, and small business advisor. He says that if you ask an entrepreneur "How's business?" he or she invariably says, "Sales are up." He never hears the response "I made a return on sales of 10 percent." Schell's goal as an advisor is to get small business owners to measure their results in real numbers, and to know those numbers, the small business owner must know the company's financials.

After years of observing and consulting, Schell realized that the majority of small business owners do not understand how to properly use their financial statements to manage and grow their business. He says the typical small business owner thinks that his or her greatest opportunities for improvement are in the day-to-day management of the business, such as dealing with employees or marketing the product or service. Few, if any, will mention learning how to use financial statements. Bankers, CPAs, and business consultants have a different perspective: they all agree that the small business owner's number one opportunity to improve day-to-day management is to learn how to better utilize the information in the company's financial statements. Having a certain level of financial literacy allows an entrepreneur to spot potential problems in the company and work more intelligently with his or her financial advisors.

Does having money in your checking account mean your business is profitable? Do you have a clear understanding of the difference between profit and cash? Which financial statement allows you to keep an eye on the financial trends of your business? You learn in this video segment that Schell wrote a book, entitled Understanding Your Financial Statements, to help small business owners. In the book, Schell starts with the basics: selecting a CPA, working with your banker, using your balance sheet to determine your business's solvency, using your profit and loss statement to manage your business's direction, understanding the concept of cash flow, and so on. The exercises below are designed to help you start thinking about, and practicing, the basics of finance. Before answering the questions and working the activities, watch the video entitled "Understanding Financial Statements, Part 1."

Questions
1. In the video, what three things does Schell say the small business owner must do to make a positive impact on his or her company's profitability? Why does Schell think that understanding the relationship among those three things is so important? How does gross margin differ from gross profit?

2. What does Schell advise Nani to do to improve her company's gross margin? Given what you learned in the text about the four variables on which net income is dependent, do you think that advice is sound? Explain.

3. What are the three parts of a financial statement? How does each part serve as a snapshot of your business in time? Create a diagram of a basic balance sheet, using the explanation and example Schell gives in the video.

Activities
1. Imagine that you are the finance person in your small business but, unfortunately, you don't have any accounting experience. Since you are expected to fi ll the role of the company's accountant, you need to purchase some accounting software. An online retailer lists the following accounting software as its top-rated sellers: MYOB Premier Accounting Small Business Suite 2007, QuickBooks Simple Start 2007, Microsoft Office Accounting Express, Timeslips 2007, and Microsoft Office Accounting 2007. Which software will you choose and why? Be prepared to share your decision with the class.

2. You've just watched the video segment and are determined to start watching your company's financial trends. You decide to build a spreadsheet to help monitor changes between the most recent month's findings and the previous month's results, which will let you set monthly goals. You know the spreadsheet will also help you write your annual business plan and make strategies for the future. You can find an excellent two-page spreadsheet for download on Inc. magazine's website at http://www.inc.com/tools/2000/10/20612.html (free with registration at inc.com), or you can build your own spreadsheet with examples found in Chapter 10. Print out the spreadsheet, with the real or imaginary name of your company as its title.

3. Most business advisors insist that an entrepreneur acquire at least basic financial skills before starting a business. As your business grows, you may need someone, such as a CPA, with the qualifications to advise you on your business finances and to prepare your income and payroll tax returns. Visit the website of the American Institute of Certified Public Accountants to learn more about CPAs and accounting regulations (http://www. aicpa.org/MediaCenter/FAQs.htm#aicpa_answer12). Summarize the answers to the following questions in a one-page report.

a. What are the requirements for becoming a CPA?

b. What is the FASB?

c. What are GAAP, and who determines them?