The underlying purpose of every company is to make money. So if you’re a manager, part of your job is to help your company earn a profit—ideally, a bigger one each year.
Of course, you may work in the nonprofit or government sector, where making money isn’t the most important goal. But you will still have to monitor the money that comes in and goes out.
Wherever you work, you can improve the financial health of your organization by reducing costs, increasing revenue, or both. You can help the organization make good investments and use its resources wisely. The best managers don’t just watch the budget—they look for the right combination of controlling costs, improving sales, and utilizing assets more effectively. They understand where revenue comes from, how the money is spent, and how much profit the company is making. They know how good a job the company is doing at turning profit into cash.
You don’t have to be an accountant to understand finance. But you do have to know just a couple of important things about accounting.
First, financial statements follow the same general format from one company to another. Individual line items may vary somewhat, depending on the nature of the business. But the statements are usually similar enough that you can easily compare performance. The reason for the similarity is that accountants all follow the same set of rules.
There are basically two different methods of accounting. Cash-based accounting is typically used by very small companies. It’s really simple. The company records a sale whenever it receives cash for a product or a service and records an expense whenever it issues a check.
The other method, accrual accounting, is a little more complicated and far more common. The company records a sale whenever it delivers a product or a service, not when cash changes hands. (That might be a month or two later, when the customer pays the bill.)
The income statement tells you whether the company is making a profit—that is, whether it has positive net income—according to the rules of accrual accounting. (Income is just another word for profit, which is why the income statement is also called a profit-and-loss statement, or P&L.) It shows a company’s revenue, expenses, and profit or loss for a specific period of time—typically a month, a quarter, or a year.
A balance sheet is a snapshot: It summarizes a company’s financial position at a given point in time, usually the last day of a year or a quarter. It shows what the company owns (its assets), what it owes (its liabilities), and the difference between them, called owners’ equity or shareholders’ equity.
A balance sheet is called that because it always balances. That is, all the assets must equal all the liabilities plus owners’ equity.
Assets are everything a company owns. The category includes cash, land, buildings, vehicles, machinery, computers, and even intangible assets such as patents. (It doesn’t include people, because the company doesn’t own its employees.)
Of course, a company has to acquire these assets. It can use its own money, which is the money its owners have invested in it plus the money the company itself has earned over time. Or it can use borrowed money. In balance sheet terminology, its own money is owners’ equity, and borrowed funds are liabilities.
A cash flow statement gives you a peek into a company’s checking account. Like a bank statement, it tells how much cash was on hand at the beginning of a period and how much at the end. It also shows where the cash came from and how the company spent it.