Deep Dive to Understanding Financial Statements for Your Small Business
Financial statements are the backbone of assessing a company’s financial health. These documents provide a clear snapshot of a business’s performance, position, and cash flows. In this post, we’ll dive into the different types of financial statements, discuss their importance, and examine how they work together to present a comprehensive view of a company’s financial status.
Three Types of Financial Statements
1. Balance Sheet
First we have the balance sheet, AKA the statement of financial position, which offers a snapshot of your small businesses financial position at a specific point in time. It lists assets (Bank accounts, Land, property, equipment), liabilities (Loans, payables, taxes due), and shareholders’ equity (owners cash put in or drawn out). The Balance sheet provides insights into what your small business owns, owes, and how much is invested.
TIP: Balance sheet accounts including bank accounts, credit card accounts, and loan accounts should be reconciled monthly or quarterly, depending on frequent statements are issued. Here is a great post on how to reconcile like a pro bookkeeper.
2. Profit & Loss (P&L)
At number two–The P&L, outlines your small businesses revenues (money brought in), expenses (money spent), and resulting net income or loss over a specific period. This statement helps assess your businesses profitability by detailing its revenue sources and cost structure.
The P&L should be reviewed monthly in some form. A few great P&L’s to run and analyze monthly are:
(1) Monthly P&L compared to Year-to-Date, (2) Monthly P&L compared to prior year, (3) Monthly P&L by Class (if applicable)
3. Cash Flow Statement
This statement is used less than the above two, but its importance for management and decision making are high. The cash flow statement tracks the movement of cash into and out of a company during a specific period. It’s divided into three sections: operating activities, investing activities, and financing activities. This statement provides a clear understanding of a company’s ability to generate and manage cash.
While the Cash Flow Statement is an official accounting report, there are many ways small businesses engineer a “Cash Flow” report that works for their company.
How the Statements Work Together
The financial statements can exist and be interpreted stand alone. But for a full company picture they must be presented together. Together they work to present a comprehensive financial picture. Below are the direct relationship each report has to one another:
Balance Sheet and Income Statement Relationship: The net income from the income statement directly affects the equity portion of the balance sheet. The balance sheet provides context for the income statement, showing the impact of net income on the overall financial position.
In non-accounting terms, at year end the net income (loss) on the income statement will be moved to the equity portion of the balance sheet so your income statement zeros out for a new year.
Cash Flow and Balance Sheet Interaction: The cash flow statement and the balance sheet are interconnected. Changes in cash reflected in the cash flow statement impact the cash balance on the balance sheet, demonstrating the relationship between cash flows and liquidity.
Again, in human language, the cash flow statement takes into account balance sheet transactions (loan payments) to show a true picture of cash flow in and out of your small business.
Insights from All Three Statements: When analyzed collectively, these statements offer a 360-degree view of a company’s financial performance, position, and cash flows. This holistic perspective aids investors, creditors, and management in making informed decisions.
Significance of the Financial Statements
Finally, lets discuss the significance of the statements and why they are important. After all, just because you can generate them and interpret them, shouldn’t you know why?
Transparency and Accountability: Financial statements provide transparency into a company’s financial affairs, fostering trust among stakeholders.
Informed Decision-Making: Investors and creditors, along with managers or owners, rely on these statements to assess a company’s creditworthiness and potential for growth. Small business owners often times us the statements to justify capital purchases or business expansions.
Business Planning: Financial statements guide strategic planning and help identify areas for improvement or growth opportunities. For most small businesses, this is true. Small businesses can review profitability and liquidity with accurate financial statements.
Legal Compliance: Companies must prepare accurate financial statements to meet legal and regulatory requirements. Small businesses need accurate statements and bookkeeping for year end tax preparation.
Financial statements serve as a compass for your small business. Decision makers must rely on the data presented in each statement and guide the business down the best road possible. Whether you’re a business owner, investor, or financial analyst, understanding these statements is essential for informed decision-making and assessing the overall health of a business.
Interested in an accounting system that can generate these statements with a click of a button? Check out Quickbooks Online, my tried and true accounting software for my small business and all my clients. If you are unsure what accounting software is right for your small business? Check out my post on accounting software options for small businesses!