First, I need to give Intuit QuickBooks credit for this metaphor. I heard them explain Financial Statements in this manner at a conference. I have taken their explanation and added more juice. So, think of the five top Financial Statements as parts of an apple tree.
The apples are your Profit and Loss Statement. Also known as the Income Statement. The Profit and Loss report tracks the business income and expenses by month, quarter, or annually. The branches are all the people that need to read your statements, investors, bankers, and tax preparers. There will be years you have a good harvest and other years where you will not. You want to sell more apples (profit) than what hit the ground and rot (loss). At the end of each year, the Net Income or Net Loss will move to the Balance Sheet as Retaining Earnings. Make sure you review this report monthly and check that your expenses are in line with your income.
The trunk of the tree is the Balance Sheet. This report reveals the health and stability of the business. It’s the strength of the business, just like the truck of the tree. It holds up the whole tree. This statement tracks the annual yields and company value. The Balance Sheet is read at a point in time, usually at the end of the month, quarter, or year. It tells investors, bankers, and lenders what your company OWN’s minus what your company OWE’s equals the Value of your Business. Investors want to make sure that if they loan you money, they will get it back plus interest.
The roots are the Statement of Cash Flows. This statement shows you where the money was absorbed into the company. Just like watering a tree, the roots need water or “cash” to live. The tree needs water to thrive, and a business needs cash to grow. The Statement of Cash Flows will show you where the cash was spent based on three areas; operating, investing, or financing activities. This statement using the information from both the Profit and Loss and Balance Sheet to show you how this happened.
Account Receivable reports are the apples you have sold on credit. It’s a detailed report of the Accounts Receivable asset account from the balance sheet. Who do you need to receive money from? Review this report often and make sure your receivables don’t get old. Keep them under 30 days.
Accounts Payable reports are the seeds, fertilizer, tools that you have purchased on credit until the apple tree products apples. Again this is a detailed report of the Accounts Payable liability account from the balance sheet. Who do you need to pay? Once you have some sales, you can pay back the vendors that helped you get started.
If you need more help understanding your statements, please email me at Nicolea.firstname.lastname@example.org.