In any market, you're going to have competitors. The key to creating great products is
If you don't understand, measure and manage the amount of cash entering and exiting your business, you are setting yourself up for failure.
Let's start with the simplest terms: Cash flows into the business from sales and cash outflows for expenses. What's left over is your profit.
Well, not exactly. There's different kinds of cash inflows (capital raises, credit, etc). And there's different kinds of cash outflows.
But for our purposes, we're going to make this as simple as possible. (Believe me, you can get extremely complicated with accounting–especially if you take venture capital to fund your SaaS business).
Three Most Important Financial Reports
1) Cash Flow Statement
2) Profit & Loss Statement
3) Balance Sheet
The Cash Flow Statement
The cash flow statement provides a summary of the major sources and uses of cash during a specific period.
The cash flow statement helps you figure out exactly where you've allocated cash, and if you're at risk of running out of it. Looking at your cash flow statement each month can help you predict your cash needs.
Reviewing the cash flow statement each month will help you keep track of:
- The flow of cash for operational activities.
- Your investments, e.g., the purchase of office equipment.
- Loan repayments.
- Whether your net operating cash flow is less than your profits after tax.
- Identifying trends in your business. For example: do you spend more money in some months, and less in others?
The Profit & Loss Statement
Also referred to as the Income Statement, your profit and loss statement (P&L) summarizes the revenue, costs and expenses your business has incurred over a specific timeframe (month, quarter, year, etc).
The P&L is typically broken down into 3 sections:
- Revenue. This is any cash coming into the business. Also knows as the "top line".
- Total costs of doing business. (Server costs, advertising, payroll, expenses associated with taxes and interest).
- Net income. Any cash left over from Revenue minus Expenses. This is also known as the "bottom line".
Determining your gross profit margin, operating profit margin and operating ratio can all be calculated with the P&L statement.
The balance sheet summarizes what your company owns: assets. And, what your company owes: liabilities.
The word "balance" is used because the assets you own must balance out against the liabilities.
On the left side, the balance sheet lists assets. On the right side, the balance sheet lists the liabilities of the business. The sources of ownership (equity) capital in the business are presented below the liabilities. (This is to emphasize that the liabilities have a higher claim on the assets.
Assets may include:
- Cash in the bank.
- Short-term investments.
- Accounts receivable.
- Inventory ... etc.
Liabilities may include:
- Accounts payable.
- Taxes and utilities.
- Bank line of credit.
- Wages payable ... etc.
Should I Hire a Bookkeeper?
I get asked this question a lot. In my opinion, you should be doing this yourself. Knowing and managing the finances in your software business is a critical business function.
Now, this article isn't going to get you to the point you need to be. So, I recommend buying some books on accounting, or take a class at your local community college (that's what I did). But, learn it.
Should I Hire a CPA?
Yes. One-hundred-percent. The tax code in the US is over 70,000 pages in length.
So, hire a CPA to do your taxes. But, do the bookkeeping yourself.