Financial statements are an invaluable tool for small business owners to gain insight into their financial health and make informed decisions. They provide investors and lenders with reports of financial information, and must also be submitted to the government, so understanding and interpreting them is essential for any business. In this blog post, we will explore why financial statements are important for small business owners and how to use them.
- What are Financial Statements?
- Why they’re Important for Small Business Owners
- What are the Financial Statements?
- Types of Financial Statements
- The Differences
- Examples of Financial Statements
- How to Prepare a Financial Statement
- Tools to Use
What are Financial Statements?
Financial statements are an invaluable tool for any business. They can provide valuable insight into the business’s financial health and help business owners make informed decisions. Understanding the basics of financial statements is essential for any business owner to make better decisions.
Those statements are used by investors and lenders to decide whether or not to invest or lend money to a business as well as to report financial information to authorities.
It’s important to call out that financial statements should be prepared carefully and accurately. They should be reviewed regularly, as changes in the business’s finances can greatly impact the statements. You as a business owners should also consult a professional if they need help understanding or interpreting their financial statements.
Why they’re Important for Small Business Owners
Financial statements are important for small business owners because they provide valuable insight into the financial health of their business. You need to be able to monitor your income, expenses, and cash flow in order to make informed decisions.
For small business owners, the financial statements are often simpler than those of larger corporates or personal statements, as the operations are usually smaller and the number of transactions is fewer. However, you still need to be aware of how the financial statements are calculated and what they can tell them about your business.
Financial statements are typically submitted to investors, lenders, and the government as financial report. For investors and lenders, the statements should be submitted when they are requested or at the end of each accounting period. For the government, the statements must be submitted according to the rules and regulations in the jurisdiction. In the United States, businesses must submit their financial statements to the IRS each year.
What are the Financial Statements?
Financial statements are financial reports that summarise the activities and financial performance of a business. They are prepared at the end of each accounting period and are meant to give investors and lenders an idea of a business’s financial health.
There are three main financial statements: the balance sheet, the income statement, and the cash flow statement.
Types of Financial Statements
The Balance Sheet
The balance sheet in accounting gives you a snapshot of your business’ assets, liabilities, and equity at a single point in time. It’s also known as the statement of financial position. At the top of the balance sheet, you’ll find your business’s name and the date the snapshot was taken.
On the left side, you’ll find everything your business owns – its assets. On the right, you’ll find everything your business owes – its liabilities and equity. This includes money owed to suppliers, employees, and the tax office. It also includes the capital contributions you made when you started the business and the retained earnings, which are the cumulative profits you’ve held onto.
When you collapse the balance sheet and look at its core components, you’ll see that the total assets must always equal the total liabilities and equity. This is due to the accounting equation, which states that assets must always equal liabilities plus equity.
The Income Statement
The income statement summarises your business’s revenue and expenses over a period of time. If the balance sheet is a snapshot of a single moment, the income statement is more like a video or a boomerang that covers a range of time.
When you look at the income statement, you’ll see a summary of your business’s revenues and expenses. When you take the difference, you can see if your business made a profit or a loss. However, it’s important to remember that profit doesn’t necessarily equal cash flow. For this reason, businesses are required to make separate cash flow statements.
The Cash Flow Statement
The cash flow statement shows your business’s cash inflows and outflows over a period of time. It starts with the opening and closing cash balances for the financial year. Then, it breaks down the cash flow from operating, investing, and financing activities.
Operating activities cover regular business activities – how much cash your business brought in and spent while selling its products. Investing activities look outside of the core operations of the business and include cash inflows and outflows from investments, buying or selling property and equipment, etc. Financing activities are all about funding the business, either through loans from banks or equity from the owners of the business.
At the end of the cash flow statement, you’ll see that the net cash flow on the top should match the net cash flow on the bottom. This means the cash flow statement is reconciled.
The balance sheet, income statement, and cash flow statement are all important documents for small business owners to understand and track.
The balance sheet gives a snapshot of a business’s assets, liabilities, and equity at a single point in time.
The income statement summarises a business’s revenue and expenses over a period of time and shows whether the business made a profit or a loss.
The cash flow statement tracks cash inflows and outflows over a period of time, broken down into operating, investing, and financing activities.
All three documents give small business owners a better understanding of their financial position and allow them to make informed decisions.
Examples of Financial Statements
Balance Sheet Example
On a balance sheet, you may see a list of assets such as cash, inventory, and property and liabilities such as loans, accounts payable, and taxes. The assets and liabilities must always balance each other out, meaning the total assets must equal the total liabilities and equity.
Income Statement Example
On an income statement, you may see a summary of a business’s revenue and expenses over a period of time. This statement can show you whether a business made a profit or a loss.
Cash Flow Statement Example
On a cash flow statement, you may see a breakdown of cash inflows and outflows over a period of time, including cash from operating activities, investing activities, and financing activities. This statement can show you how much cash your business is generating or using.
How to Prepare a Financial Statement
To prepare financial statements, you should first understand the basics of each statement. This includes understanding the components of the statements and how they are calculated, as well as the accounting equation and how it applies to the balance sheet.
You should then use accounting software and/or spreadsheets to track income, expenses, and cash flow and generate the statements. It’s important to review the statements regularly and check for any errors or omissions. If help is needed, entrepreneurs should consult a qualified accountant or financial advisor.
Tools to Use
For the balance sheet, you can use accounting software such as QuickBooks or Xero to create a statement a spreadsheet software such as Microsoft Excel or Google Sheets.
For the income statement, you can use accounting software or a spreadsheet to track and calculate their income and expenses. You can also use a specialised tool such as Profit and Loss Report to generate the statement.
For the cash flow statement, small business owners can use accounting software such as QuickBooks or Xero to generate the statement. They can also use a spreadsheet such as Microsoft Excel or Google Sheets to track their cash inflows and outflows, and then create the statement.
To briefly summarise the 3 key financial statements:
- The balance sheet gives us a snapshot of a business’s assets, liabilities, and equity at a single point in time. It shows us what the business owns and what it owes, and how much the business is worth to its owners
- The income statement shows a business’s revenue and expenses over a period of time. When you take the difference, you can see if the business made a profit or a loss
- The cash flow statement reveals a business’s cash inflows and outflows over a period of time. These are reconciled back to the movement in cash in the balance sheet
There you have it! Hopefully, this article gave you some insight into the basics of finance statements. They’re essential for any business, so understanding them is important.