In an ideal world, it would be great to update your financial statements every month. For a larger business with a full accounting staff that would certainly be appropriate. However, in a smaller business where you the entrepreneur are also your own CFO, you may be wondering if monthly updates of all your financial statements is really necessary.
This issue reminds me of a discussion I had years ago with one of my favorite business school professors, Bill Bruns, who taught, wrote and consulted about issues involving accounting and management control systems. I asked Bill how much financial detail I should go into when preparing a case for class. Bill responded that I should decide for myself whatever level of detail was appropriate for that particular situation. Should I write out my notes or just think this through verbally I asked Bill. Again, he responded that I should decide for myself what was appropriate.
Taking the spirit of Bill Bruns’ advice, I would suggest that if you are running a very small business that you don’t necessarily have to update your financial statements every month. Instead it is worthwhile to think why you are updating your financials and if the information you receive will justify the time it will take.
Generally, even for a very small business, I would update the income statement every month. Then I would compare it to the budget. (The budget could also be called your pro forma income statement). Then I would run a variance analysis. If I was significantly over on a particular budget item then I would dive into it, figure out why it was running over budget, and try to make changes to avoid future overruns. If sales were running less than expected then I might consider cutting expenses across the board.
Ideally you should update the income statement immediately after the month ends. This allows you to use the knowledge that you gain from the new income statement to implement changes before you are too deep into the following month.
For years in my businesses I would push and pull my accounting manager or CFO to update financial statements as close to the beginning of the month as possible, but often I would get lots of push back, and lots of explanations about how much time it would take. Generally, I think any financials that you update should be done within the first 3 days of the month and at least within the first 7 days of the month.
Every actual monthly income statement is going to have at least some variance from your budget (or your pro forma income statement). It also may suggest that your budget for future months should be revised. For example, let’s say your electricity bill starts coming in 7% above budget and you now realize that under budgeted electricity costs for all months. So, should you revise your monthly pro forma income statements? No. Unless you expect future monthly income will be dramatically different than projected, I would not take the time to revise them.
The balance sheet I would likely not update monthly for a very small business unless there was a particular reason to do so. If you are using bank lending then you probably would be required to submit a monthly balance sheet so you might not have a choice. Beyond bank requirements, the reason I would be most likely to consider updating the balance sheet monthly would be if I had a particular reason to be concerned about the financial condition of the business.
However, if I was concerned about a particular aspect of the balance sheet, such as the aging of receivables, then I would just look at the receivables, starting with an aging statement of how much money was over 90 days, over 60 days, etc.
What about pro forma monthly balance sheets: should they be revised every month? Frankly, I don’t even take the time to create pro forma monthly balance sheets in the first place, unless I am borrowing from a bank that requires them.
But if I have a concern about the business running out of cash, the most important financial statement to update is the pro forma (projection of) cash flow. Even if a business is solidly profitable, even if it has a decent balance sheet, it can still run out of money. This is especially true for fast growing businesses. So, if I am really concerned about cash flow, I might even update the cash flow projection more than once a month.
So, what’s the bottom line on how often you should update your financial statements? The truth is, it depends. For example, if you are running a one-person service business without any borrowing needs and solid, consistent profitability, then I would update the income statement every month, but the balance sheet I might only update once per year. For this business, I probably wouldn’t even create a cash flow at all.
On the other hand, if I felt that this same business had even a chance of running out of money let’s say 6 months in the future, then I would create a new pro forma cash flow every month. I then also might create a balance sheet every quarter to help get a more complete picture of the financial health of the business.
This subject brings me to one of my generalizations about how to run a business better: it is highly worthwhile to spend some time thinking about what where your precious time will be spent, rather than just diving into the work in front of you.
By Bob Adams, Serial Entrepreneur and Founder of BusinessTown.com.