Community Futures Meridian

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Understanding Financial Statements

  • March 3, 2017
  • Written by Meridian Admin

Many entrepreneurs start a business because they have a passion for a product, or a service, or perhaps because they want to be their own boss. Others may be pushed into it for one reason or another; maybe they were laid off, or couldn’t find a job which used their specific skills where they live, or they simply saw a gap in the market – an opportunity.

This means that to many business owners the financial accounting side of the business has been somewhat of a mystery – something best left to their accountant. But knowing a little about a few of the basic financial statements and tools used in business is important and can help you protect your business and its hard-earned dollars.

Here is a short overview of three basic, but vitally important, financial documents every business owner should at least have a passing acquaintance with.

Balance Sheet

This is a financial statement that shows you the assets of your businesses, the liabilities and your equity (and that of any shareholders you might have). It’s a snapshot of a specific moment in time. This moment is usually your year end, but it can be done quarterly. It is sometimes referred to as a Statement of Financial Position.

What does it tell you?

What you own, owe and what has been invested. Basically this comes down to a simple formula of Assets = Liabilities + Shareholder’s Equity. And yes, the two figures always balance.

Why is it important?

It provides you with a snapshot in time of your company’s financial situation – it’s health. Knowing what you own and owe is vital to starting to plan for the next year, or next phase of your business.

This document also assists current and potential investors, and bankers, to understand your company’s financial situation and how their money might be used. It provides an insight into what future return might be expected. For instance, investors particularly look for businesses with good cash assets as this indicates a company that is likely to continue to grow and be successful.

Income Statement

The income statement is sometimes called a profit and loss statement, which in some ways explains better what it actually is. This document shows all revenue coming into the company and all costs of doing business, both fixed and variable, and then shows whether over a set period of time the company has made or lost money.

What does it tell you?

The income statement shows the profitability of the company by showing revenues and expenses during a specified period of time. This can be over any period and can be done monthly, quarterly and annually. It is compiled from the figures in the company’s books and put into this concise document.

In short it provides you with three things:

1. Total revenues

2. Total expenses

3. Net income

Why is it important?

It provides an accurate picture for management of how the company is doing in terms of profitability over a period of time. It is a document that bankers and investors are keen to see when looking at lending money to, or investing in, your company. As a company owner it allows you to better identify what your costs are, identify possible cost reductions, calculate your profit margins, and provide information which will help you predict your cash flow over the next period.

Cash Flow Statement

The cash flow statement records the amount of cash and cash equivalents entering and leaving your company over a specified period of time. It is also known as a statement of cash flows. A cash flow statement is prepared on the accrual basis of accounting which means that not all cash recorded will have been collected, nor expenses paid.

What does it tell you?

This document indicates what cash will be flowing into your business over the specified period and what will be flowing out. It will tell you whether you are looking at a positive or negative cash situation. The cash flow statement focuses on operational, investment and financing activities that create and use cash.

Why is it important?

The cash flow statement is important because it provides information about not just what has happened, but what will be happening during the prescribed period. It allows banks and investors to see where your income is coming from and what you are spending money on, and identify trends in your business.

There is an old saying that “cash is king” and this document shows you whether your company is, or will be, in a cash flow positive or negative situation during the period it covers. It is vital that your company has sufficient cash (or the ability to raise it) to pay its bills. A company can be making a good profit on paper but still fail, if it doesn’t have enough cash to satisfy its creditors.

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This article provides only a brief overview; we urge you to learn more about these three important financial documents and understand their nuances (perhaps ask your accountant to explain them fully) so you can use them to ensure your business continues to enjoy a secure financial footing.