Starting and managing a
small business venture can be thrilling, yet it poses unique challenges,
particularly when it comes to finances. Although not everyone who starts a
small business has knowledge of financial management, there are things every
entrepreneur should learn to succeed, such as how to read financial statements.
Even if you are not handling your accounting yourself, learning about financial
statements can come in handy in terms of analysis. This post explores why financial
statements are necessary for small business owners.
What Are Financial
Statements?
A financial statement is an
important business document that reflects all the information regarding your financial
transactions. It helps you share information with others who need to know your
company's true financial state.
Here is how these documents
serve a few crucial purposes:
• They record all money transactions made by your company
• They give an overall picture of your company's financial
performance
• They help you comply with legal requirements established by
governing bodies
• They allow you to make better-informed decisions regarding
your company's operations
• They help build trust with investors and partners
The usage of these
statements varies depending on the type of business. A restaurant could use the
income statement's food expense statement to set product prices. The tech
startup could use the balance sheet to demonstrate potential growth to
prospective investors. The construction company could use cash flow statements
to ensure that the next material purchases would be financed.
Why Business Must Develop Financial
Statements?
Sole proprietors require
statements for tax purposes, whereas public companies must provide quarterly
and annual reports. Nonprofit organizations need the statements for grant
applications and for transparency.
There are certain key
principles of financial reporting that should be followed:
• Consistency – the same accounting principles are used every
year
• Accuracy – reporting of the true financial position without
any mistakes
• Timeliness – timely provision of information
• Completeness – inclusion of all financial transactions
• Transparency – easy-to-understand information
If you receive financial
statements late or with mistakes, their value diminishes dramatically in terms
of business decision-making. Now that we have learned about financial
statements, let’s discuss the most important of them, the Income Statement.
Types of Financial
Statements
The following financial
statements must be prepared by every small business owner: a balance sheet, a profit
and loss statement, and a cash flow statement. These three statements will give
you an understanding of your firm's financial state.
1. Balance Sheet
A balance sheet provides an
overview of your business's assets, liabilities, and equity as of a specific
date.
• Assets - These are resources owned by your business, such as
cash, accounts receivable, inventory, and other long-term assets.
• Liabilities – money owed to the firm, including accounts
payable, debt, and other obligations.
• Equity – the net asset value of the firm, equaling assets
less liabilities.
The balance sheet is a
valuable tool for determining the financial strength of your business. It tells
you what assets you have and how you acquired them.
2. The Income Statement
Otherwise referred to as
the Profit & Loss Statement, an income statement is a summary of the
revenues and expenses for your business during a certain period, which can be
monthly, quarterly, or annually.
• Revenue: This is the total amount of money received through sales of goods and services.
• Expenses: Expenses are the costs incurred in earning revenues; for example, cost
of goods sold (COGS) and other overhead expenses.
• Net Income: This is the net profit earned by your business at the end of the period
after deducting the expenses from the revenues.
The income statement helps
you to gauge the profitability of your business.
3. The Cash Flow Statement
Cash Flow Statement depicts
the movement of cash into and out of your business within a particular period.
The following are the three main categories in which cash flows are classified:
1. Cash Flow from Operating Activities – Cash flows from the operating activities of your core business (customer collections, supplier payments, payroll, etc.)
2. Cash Flow from Investing Activities – Cash flows from buying
or selling fixed assets and investments in your business (equipment, property, &
securities, etc.)
3. Cash Flows from Financing Activities – Cash flows from
financing activities undertaken by you to fund your business (loans
taken/repaid).
Monitoring cash flow in
your business is important because it determines whether your business can
finance itself.
Why Financial Statements
Matter
Financial statements are
useful tools that provide insight into your business's financial position. Here
is what they can tell you:
• Liability. You can gain information regarding liabilities
and the ability of your company to settle them.
• Profit and loss. Your profitability can be analyzed with
ease.
• Trends. It can be established if there is an upward or
downward trend in your profitability.
• Investment requirements. The level of investments required
for the growth or sustaining the operations of the firm.
• Efficiency. Compare the operational costs of your business
to the revenue they generate.
Building Financial
Capabilities
However, if one does not
have confidence in his or her financial abilities, some things could be done to
enhance financial awareness:
Utilize
Financial Software: Using programs such as QuickBooks or Xero will help manage
finances better.
Delegate
Finances: One can employ an accountant or bookkeeper, or hire an accounting
firm like Accure CFO, who would keep your
finances organized and up-to-date.
Education:
Read books or take financial classes to learn how to deal with finances
properly.
Conclusion
Knowledge about financial
statements is one of the most important things that a small business owner
should know. Financial statements give you an idea of how well your business is
performing and allow you to make wise decisions. It is advisable to be conversant
with such financial documents as the balance sheet, income statement, and cash
flow statement.
If you would like help
understanding your financial statements or want to explore our services, feel
free to reach out to us at info@accurecfo.com.
