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The Tech Founder's Guide to Financial Statements: Cash Flow vs Balance Sheet vs Profit & Loss

Last week, we armed you with the basic terms for financial literacy. Today, you'll learn how to read and understand the three basic financial statements to help you run your tech services startup.

The three basic financial statements are the Profit & Loss Statement (P&L), Balance Sheet, and Cash Flow Statement. In this article, we'll delve into these statements, highlighting their significance, how they're used, and key insights to glean from them.

Profit & Loss Statement (P&L)

The Profit & Loss Statement, also known as the Income Statement, provides a comprehensive overview of a company's revenues, expenses, gains, and losses over a specific period, typically quarterly or annually. All moneys are calculated on an accrual basis.

It is a crucial measure of a company's profitability, indicating whether it has generated a profit or incurred a loss during the period. It is the first statement analyzed when looking at the business's health. When analyzing the P&L, focus on revenue trends, gross profit margin, operating income, and net income to gauge the company's revenue-generating capabilities, cost management efficiency, and overall profitability.

A tech services company should pay close attention to the following on their P&L:

  • Revenue to understand the size of the business

  • EBITDA to understand the profits

  • Gross margin to understand the premium commanded

  • Growth rate to understand the future potential of the business

  • Percentage of costs going to COGS, Sales and marketing, and operations to compare against industry benchmarks

Balance Sheet

The Balance Sheet offers a snapshot of a company's financial position at a specific point in time, presenting its assets, liabilities, and shareholders' equity. It provides valuable insights into a company's liquidity, solvency, and overall financial health.

The information in the balance sheet helps you understand the money in the company. In addition, it is a critical financial statement needed when raising debt. When examining the Balance Sheet, consider the composition of assets and liabilities, assess liquidity using metrics like the current ratio, and evaluate financial leverage with the debt-to-equity ratio.

A tech services company should pay particular attention to:

  • Accounts receivables vs accounts payables to understand efficiency in converting cash

  • Debt-to-equity ratio to understand financial stability

  • Return on equity to guide investment decisions

Cash Flow Statement

The Cash Flow Statement tracks the inflow and outflow of cash into and out of a company during a specified period, categorizing cash flows into operating, investing, and financing activities. It offers critical insights into a company's cash-generating capabilities, investment decisions, and financial obligations.

The cash flow statement helps you understand the runway for your company. When analyzing the Cash Flow Statement, pay attention to operating cash flow trends, free cash flow, and the relationship between cash flows from different activities to assess the company's financial flexibility and ability to meet its obligations.

A fast-growing tech services company needs to pay attention to the following the Cash Flow Statement:

  • Estimated cash-zero date forecasted from the inflows and outflows to anticipate any financial crunches

  • Cash conversion cycle to understand how efficiently your company converts work into cash

  • Free cash flow to understand the war chest available for investment

The 3 Financial Statements & Tech Services

Understanding the Profit & Loss Statement, Balance Sheet, and Cash Flow Statement is essential for tech services founders. These statements provide vital insights into revenue, financial health, and cash flow. By leveraging the collective wisdom of these statements, founders can navigate challenges and seize opportunities, guiding their companies toward sustainable success in the dynamic tech services industry.

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