When a creative strikes out on their own as a freelancer or small business owner, there are some financial basics that they need to master. And one of those basics is understanding your bottom line. And to get that, you have to crack the code of understanding your balance sheet.
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The creative mindset may very well be the polar opposite of an accounting mindset. While there are always exceptions to making generalizations like that, I’ve not run into many creatives that totally understand their books, or accountants who moonlight as designers for that matter. But when a creative strikes out on their own as a freelancer or small business owner, there are some financial basics that they need to master. And one of those basics is understanding your bottom line. And to get that, you have to crack the code of understanding your balance sheet.
I began my first design firm back in 1995. It was a web design firm, and so for the first five years I experienced nothing but rapid growth. There was plenty of work, and while my profits could have, and should have been even better than they were—had I known how to manage the business side of creativity back then—it was a profitable business. But then came the dot com bubble burst of 2000, followed by 9/11, and suddenly, all those profits were swept away.
Major crises like that, not to mention the one we’re all facing now in 2020, can have a massive impact on profitability. But even when things are going well, and work is steady, it’s important to keep an eye on your profitability—to have a grasp on your bottom line. A business that lacks profits, is not going to be in business for long.
It’s critical to understand a few key financial reports, including your balance sheet. Unfortunately, the balance sheet is one of those financial documents that’s not intuitive and has terminology and categories that can be confusing. But here’s the good news—even if you never get a handle on the complete structure and concepts of your balance sheet, there’s really just one line that matters—your total equity. The total equity of your company is, in fact, what they mean by your bottom line—since it’s found at the bottom of your balance sheet. Though in Quickbooks it’s actually the second to bottom line.
Your total equity, as expressed on a balance sheet, is a snapshot of the cash value of your company at any given time. It’s the net leftover of all your assets after taking into account all of your liabilities. It’s the value of your company, should you theoretically end your business, selling off all your assets, and paying everything you owe. If you were going to sell your company, this total equity number would be the most concrete basis for determining the value of the sale. Wouldn’t you like to know what that number is? It’s extremely rare to actually sell a creative practice, especially a freelance one, but knowing the concrete value of the company you’re striving to build is something you ought to care about.
If you’re running a profitable practice your total equity line will show steady increase month by month. If you’re breaking even it’ll be relatively consistent month after month, and if you are operating unprofitably it will be slowly descending, until you’re so pressured by financial trouble that you go out of business.
Now there are some reasons why, if you track your total equity over time that you will see it go up and down—even if you are operating profitably—but while there can be dips even in a profitable practice, the overall trendline will show a growing increase in value.
As a business owner, at the very least, you should be running a balance sheet report after closing out your books at the end of each month, and taking a look at your total equity line item, comparing it to the preview months, quarters, and years. If that number is not rising, you can know with absolute certainty that you are not operating profitably. It’s really kind of amazing that this one number reveals so concretely how you’re performing.
If your total equity is not rising—your balance sheet can’t tell you exactly why that’s the case—that would require a more detailed analysis—but it absolutely will tell you when that kind of analysis is needed. If you’re a creative entrepreneur and you’re not using these financial reports—you’re really flying blind. It might not come naturally, but you need to become familiar with these basics—if you’re going to build an enjoyable, sustainable, and profitable creative business.
Until next week: don’t let the business of creativity overwhelm your creative business.