- November 8, 2018
- Posted by: Rivero, Gordimer & Company
- Category: Business Advice
Most entrepreneurs start their business because they are passionate about their product or service — not because they enjoy managing financial statements. However, accurately tracking and managing your finances is one of the most important areas of an efficiently-run small business.
Most of the time, the smartest way to ensure accurate financials is by hiring a local CPA to handle your financial statements. However, some small business owners prefer to manage their finances internally. If you want to handle your finances, it starts by first understanding the necessary financial statements for your small business.
Why Are Financial Statements Important
Before we dive into the financial statements, it’s a good idea to explain why financial statements are so important to your small business. The most obvious benefit to accurate and up-to-date financial statements is the insight it provides you about the health of your business.
While each financial statement has a different purpose, they can all help you assess your organization. For instance, the statement of cash flow shows how cash (one of the most valuable assets) moves throughout the business — which can reveal excess spending or an inability to collect on accounts receivables, among other things.
Proper financial statements are also important when dealing with third-parties such as investors or lenders. If you are seeking additional capital through funding partners, they will likely ask for more information about the current financial health and growth projections of your business. This information can be gleaned from your financial statements.
As you can see, financial statements can help you run a more efficient business, and they provide the foundation needed to help grow your business.
The Income Statement (Profit and Loss Statement)
The income statement, also known as the profit & loss statement (P&L), displays a company’s revenue, costs, and expenses during a defined period of time. The income statement is a great tool to determine net profit for a specified period. In fact, this financial statement is often the one used by lenders or investors to assess the profitability of your business during a given timeframe.
Moreover, you can determine your company’s net income by subtracting the total expenses from your total revenue on the P&L. This calculation will determine the amount of revenue that your business needs to pay taxes on for the year.
From an accounting perspective, whether you use a cash or accrual accounting method will affect the numbers found on your income statement. The cash method requires the exchange of money, while an accrual method recognizes income and expenses once incurred.
For more information about accounting methods and the nuances of the income statement, contact the Tampa CPA Firm, Rivero, Gordimer & Company.
The Balance Sheet
Unlike the income statement which provides a granular look at your financials, the balance sheet aims to take a more macro-view of your business’s financial health.
The balance sheet divides your company’s financials into three major components: assets, liabilities, and equity. Your assets should always equal your liabilities and equity combined.
This financial statement has two sides; on one are your assets and the other are your liabilities and equity.
Assets are tangible and intangible resources which provide value to your business. On the balance sheet, you will often divide assets into two categories: fixed and current.
Fixed assets are typically long-term assets that are essential to your business and you do not intend on converting to cash in the short-term. Examples of fixed assets could be building, land, machinery, or other operating equipment. Current assets are resources that can be easily liquidated or are presumed cash-equivalent. Examples of current assets include cash, inventory, or accounts receivables.
On the other side, you have liabilities and equity.
Similar to assets, liabilities can also be divided into two main categories: short-term liabilities and long-term debt. As you might expect, these two categories are based on the timeframe within which each is due to be reconciled. Short-term liabilities include accounts payables or taxes. Long-term debts are usually business loans or notes payable.
Under equity, you typically have either reinvested capital and retained earnings.
Not surprising, the balance sheet is meant to maintain a balance between your assets and your liabilities and equity. In other words, when recorded properly, these two sides will be equal. This macro-view of a company’s financial health can very quickly provide insight that is useful when making strategic decisions such as whether to add more long-term debt through a second business loan.
Cash Flow Statement
Your cash flow statement provides a pulse on the movement of money in and out of your business. Incoming transactions on your cash flow statement show cash or revenue that is going into your business. Outgoing transactions show the amount of cash that you are using to meet your daily operational needs.
This financial statement can reveal pitfalls in your operational efficiency, or it can show a thriving business — depending on the amount and rate at which cash flows into and out of your business.
A cash flow statement has three components.
- Operations: This category consists of the functions necessary to operate the business, such as accounts receivable, accounts payable, and inventory. This is calculated by taking the net income less operational costs.
- Investing: This component includes capital generated from investment activity. These are usually purchases or long-term changes to equipment, or other business assets.
- Financing: The third activity covers cash flow from acquiring and repaying debts. While these financial activities won’t affect your business’s bottom line, they will have an effect on how much cash your business holds.
Financial statements can be daunting, but with just a little effort you can put yourself in a better position to make savvy decisions on behalf of your business. No matter the size of your organization, whether you handle your own bookkeeping or hire a local CPA Firm, make sure you take the time to truly understand the three financial reports described above.