You Can't Judge a Book by Its Cover...or a Business by Its Bank Balance

We've all heard the saying, "You can't judge a book by its cover." The same is true for your business. If you want to know how your business is doing, where would you begin? Many business owners start by looking at their bank balance. It's a reasonable place to start...but is it enough?

Consider these two businesses. One has $18,000 in its business checking account. The other has $800. Which business would you say is doing better? The answer depends on information your bank balance alone can’t tell you.

First, when during the month did you look? The timing alone can make a healthy business appear to have plenty of cash—or very little. Now consider a few other questions. What payments are still due? Are there customer payments that haven't been received yet? Did the business actually earn money this month? Without answers to those questions, there is only one thing you know for certain: at that moment, one business had $18,000 in the bank and the other had $800. That's all.

Now let's fill in the missing pieces. The business with $18,000 in the bank still has payroll due next week, rent due in a few days, a loan payment coming up, and sales tax that hasn't yet been paid. The business with $800 in the bank has already paid all bills for the month. It also expects to receive several customer payments over the next few days. So which business is doing better now?

At first glance, many people would still choose the business with $18,000. But think about it for a moment. If the first business pays payroll, rent, its loan payment, and sales tax, how much cash will remain? If the second business has already paid those obligations and expects to receive customer payments soon, what is likely to happen to its bank balance? Suddenly, the gap between the two businesses doesn't seem nearly as large. Based on what we know, both businesses appear to be in very similar financial positions. One simply looked at its bank balance before paying many of its monthly obligations, while the other looked after most of those obligations had already been paid.

The difference wasn't the financial condition of the business. It was the timing. 

The bank balance answered one question: How much money was in the account at that moment? It didn't answer the bigger questions.

So where does the rest of your business's financial story come from? It comes from your financial statements and other accounting reports. Together, they provide a much clearer picture of how your business is really doing.

Do you want to know whether your business earned more than it spent during the month? Look at your Profit & Loss Statement.

What if you want to know what your business owns and what it owes? Better yet, how much of the business actually belongs to you? Your Balance Sheet tells that story.

If you want to understand why your cash increased or decreased during the month, that story is told by your Statement of Cash Flows. It helps connect the dots between your profitability and your bank balance.

Now you know where to find the answers. Your financial statements, along with other accounting reports, when needed, work together to tell the financial story of your business in a way your bank balance alone never can. Did your business earn more than it spent? What does it own and what does it owe? What payments are still due? Are there customer payments that haven't been received yet? Those are the kinds of questions that help you understand how your business is really doing.

Whether you maintain your own books or work with a bookkeeper, understanding which report answers which question will help you make better business decisions.

Your bank balance is an important number. But you can't judge how well your business is doing by your bank balance alone.