Knowing how to work with the numbers in a company’s financial statements is an essential skill for small business owners. The meaningful interpretation and analysis of balance sheets, income statements, and cash flow statements can help entrepreneurs determine the health of their business and make better business decisions.
With a solid understanding of the financial statements, a small business owner will know, and more importantly, understand how to take action. Knowing what the numbers represent and what they are telling you, allows you as a business owner, to succeed on purpose. The income statement, balance sheet, and cash flow statement provide the most comprehensive view of any business. That’s why they’re considered essential components of a business plan. Outsourced accounting services can be extremely beneficial to entrepreneurs who don’t feel they have a good grasp on their financials, and many small businesses do outsource their finance and accounting departments. This way, a certified professional can explain and help you understand what’s going on with all the numbers.
Even if your small business does choose to hire outsourced accounting services, its essential to understand what role each of these financial statements plays, and how to interpret the data they produce. Here’s an overview of how they can help you keep your finger on the pulse of your company’s financial position.
The Balance Sheet
The balance sheet provides a snapshot in time of what is owned (assets), what is owed (liabilities), and what is left over (net worth or book value). Your business’s Balance Sheet shows you at a glance a snapshot in time how everything is balanced.
- It will quickly tell you what you have, are owed, and what you owe to others.
- It shows how much you profited in total this year as well as how much net investment (equity) you have in the business.
- It tells you, in detail, how much money you have (checking, savings, etc) as of a certain date.
- It shows the value of your equipment and other assets as well as your payables and other liabilities.
The balance sheet is the foundation for understanding your financial situation and making sure your books are accurate. Although it can seem a little overwhelming it is incredibly powerful for providing a glimpse into the following:
- Your company’s net value
- How much you are currently owed
- How much you owe
- Liquidity ratios (how readily you can turn an asset into cash, should you need it).
By comparing balance sheets from period to period, you can see changes in your cash position, accounts payable/receivable, inventory, equity, and retained earnings.
If your small business is looking for outside financing, it is important to note that the balance sheet is an investor’s preferred starting point for building a picture of your business’s fiscal health. The balance sheet summarizes key financial information on a given date, as opposed to the income statement, which shows profitability over a period of time. It is a good indicator of your company’s stability and liquidity, which are both important factors in determining your business’s ability to sustain itself without outside financing.
If your business is looking for a small business loan or outside financing, outsourced accounting services can ensure that your balance sheet is in tip-top shape as well as explaining everything you need to know on this financial statement.
The Income Statement
The Income Statement (also known as a “Profit & Loss Statement” or “P&L”) gives you a snapshot in time of sales (Revenue), expenses, and profits for a specific period – from daily to yearly and anywhere in between.
An income statement is a versatile report that gives you a simple way to see where you are making money and where you are losing money. It can give you ideas about how to increase profitability by either investing more in high revenue generating activities or cutting costs. The income statement also tells you how much cash is left to pay your salary, reduce company debt, or reinvest in the business. Once you “get it” on this one, you’ll wonder how you lived without it!
If your small business is looking for outside financing When investors look at your business plan, they will use your income statement to assess the level of risk involved in extending credit or venture capital your way.
However, there are some things that your income statement won’t tell you. It won’t indicate whether your overall financial condition is weak or strong (refer to your balance sheet for this), how cash is actually moving in and out of your business (refer to your cash flow statement), or list any assets you own or liabilities you owe (again, see your balance sheet).
The Cash Flow Statement
Failure to manage cash flow is one of the top reasons small businesses fail. That’s because cash doesn’t always flow into your business at the same rate that it exists it! In fact, small businesses generating profits can still have cash flow problems.
Cash flow is nothing more than the movement of money into and out of your business. You may simply want to know if you can pay your bills on time. Whereas a creditor might be looking at your business to determine if you can repay a loan. No matter what decision you’re facing, this report can be a very valuable tool!
Your cash flow statement has three parts:
• Operational Costs – This includes your net income and losses, minus your regular expenses, and is the one number that you’ll want to see growth in because it provides an accurate picture of the cash you are generating before any costs associated with financing or investments are taken into consideration.
• Asset Investments – This section reports both inflows and outflows from purchases and sales of long-term business investments such as property, assets, equipment, and securities.
• Financing – This is the cash you’ve received as a result of a business loan, line of credit, the sale of stock, or other capital infusions.
While your income statement can tell you whether you made a profit, it doesn’t take into account delinquent or missing payments or help you determine whether you actually generated enough cash to stay afloat.
The Power Of Three
While the cash flow statement is often considered the most important financial statement for a small business, the three main financial statements are interrelated. Viewing them holistically can help you make smart financial, investment, and management decisions for your business.
Whether you’re a do-it-yourself or rely on guidance from outsourced accounting services, learning certain fundamental financial statement analysis skills can be very useful.
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