What the Heck Is My Accountant Saying? How to Read Your Financial Statements
If your accountant has ever told you, “Your P&L looks fine, but your shareholder loan is a problem,” and you nodded along while discreetly Googling under the table, this post is for you.
The thing is, most business owners never went to business school, and accountants aren’t exactly trained in bedside manner. We’re taught ethics and accounting standards, not how to explain things in plain English. So the gap isn’t your fault. Let’s close it!
Start with cash vs. accrual
Cash follows the money. Accrual follows the work.
Cash basis records income when it hits your bank account. Accrual records it when you’ve actually earned it. Most bookkeepers work on a cash basis during the year, and then your accountant makes adjustments at year end. Ask which one you’re on, because it changes how your reports look.
Say you run events and sold tickets before year end for an event happening after it. That money isn’t revenue yet. If the event were cancelled, it would go back to the ticket holders, and you haven’t spent the expenses either. Without accrual, you have no idea what your profit really is.
The balance sheet: a snapshot of what you own and owe
Think of it as a net worth statement for your business on one specific day. Assets minus liabilities equals equity, and the math always works out.
What you own:
Accounts receivable is the IOUs. It’s work you’ve done and invoiced but haven’t been paid for. Ask how long it takes your clients to pay, because if your team gets paid every two weeks and clients pay in 60 days, that gap affects every decision you make.
Inventory is always listed at cost. If you make candles, that’s the wax, wicks, jars and labels.
Prepaid expenses and deposits are money you’ve sent out for something you haven’t used yet. A $360 software subscription isn’t worth splitting up, but a $10,000 insurance policy is.
Fixed assets are big purchases that last more than a year, so they’re written off a little at a time. Your vehicle might show at $20,000 on the books when it’s worth $40,000. Ask your accountant what happens if you sell it.
What you owe:
Accounts payable is the bills on the fridge. Compare it to your cash and receivables. Can what’s coming in cover what’s going out?
GST payable is not your money. You collected it on the government’s behalf. It’s one of the biggest mistakes I see, because it lands in your bank account and feels like yours.
Deferred revenue is money clients prepaid for work you haven’t done yet. Sell 12-month programs right before year end and you’ll have a big cash injection, but it has to carry you through the next 12 months.
Shareholder loan tracks money moving between you and your company. If the company owes you, that money can come back to you tax-free. If you owe the company, it’s a tab you need to settle, and there are tax consequences if you don’t. If you put personal line of credit money into the business, ask your accountant to track it separately so it doesn’t get confusing later.
Retained earnings is a scorecard. It’s not a bank account, and it’s not what your business is worth. Your brand, your reputation and your ability to make consistent profits (goodwill) don’t show up anywhere on this report.
The P&L: a video of the period
The profit and loss statement runs from revenue to net profit, and it’s where you find your levers:
Revenue: Should you charge more? What does the rest of your industry charge?
Cost of goods or services: Can you negotiate with suppliers, find new ones, or deliver more efficiently?
Operating expenses: Have you committed to too much for your revenue, or are you running so lean that your people don’t have what they need?
Gross margin is just gross profit as a percentage. Sell a $100 t-shirt that costs you $40 and you keep $60, a 60% margin. That’s what’s left to pay for everything else.
The owner reality check
If you deliver the service yourself, your time probably isn’t in the numbers. Imagine your business had to pay someone to do your job. What would that cost, and what would it do to your profit? One of my clients was barely breaking even each month and felt discouraged. When we adjusted their P&L for what they’d pay someone else to do their job, the business was actually quite profitable. Others find the opposite, and either way you want to know before you hire, get sick, or want to step back.
Why your profit doesn’t match your bank balance
This is where most of our clients get their aha moment. A shop might do $500,000 in sales with $40,000 in profit and still have tight cash. That’s because the profit went back into inventory and into paying off the loans that funded it.
Look only at the P&L and you can look profitable while you run out of cash. Look only at the balance sheet and you might have cash in the bank and not realize you’re losing money every month. The P&L answers “Am I making money?” The balance sheet answers “Am I okay? Where did the money go?” You need both.
Your homework
Before your next meeting with your accountant, pull your P&L and your balance sheet and write down one question about each. Walking in prepared changes the conversation.
To make this easier, I put together a free download that walks through a sample product business and a sample service business, with both reports explained line by line. Grab the free guide here!
And if you want to hear the whole thing, you can listen to the full episode here.
Next up, I’ll break down the terms like KPIs, CAC and ROAS that get tossed around online. If there’s a piece of lingo you want explained, send me a message and let me know.