Accounting 101: Financial Statements

Financial statements report on the overall health and detailed aspects of a company. The most common one is the Profit and Loss Statement, also called the Income Statement. After that the second most common is the Balance Sheet. Third, and arguable the most important, is the Cash Flow Statement. The Statement of Owners Equity is another common but much less frequently reviewed report. These are the reports we hear about most, but there are literally dozens more. Let’s go over the common financial statements, as well as a few more that are pertinent to most small businesses.

Income Statement

Arguably the most common and most used of the financial statements, the Income Statement shows if a company is making money. It shows revenue and expenses over time, and the difference between them is net income. This report is useful to assess profitability, manage expenses, and forecast future performance. Also, it is a great reference when setting and tracking goals.

Balance Sheet

A Balance Sheet shows what a business owns, owes, and its net worth at a specific point in time. It balances – as the name implies. What a company owns (assets) equals what it owes (liabilities) plus the net worth (equity). Many small businesses don’t think much about their Balance Sheet, but it is very useful for analyzing operations and health.

Cash Flow Statement

The cash flow statement marries the Income Statement and Balance Sheet together. It starts with the net income from the Income statement and shows the changes in accounts to arrive at the ending cash balance as reported on the Balance Sheet. This report is critical to understanding where your cash is going! Small business owners should pay attention to this report. Cash flow is the number one reason why small businesses fail.

Statement of Owners Equity

The Statement of Owners Equity is a detailed view of the Owners Equity section on the Balance Sheet and shows what transactions changed the balances. It will start with the prior period Owners’ Equity, detail each type of equity transaction and the amount, and totals to the ending Owners’ Equity as reported on the Balance Sheet. Examples of equity transactions are owners’ draws, current year net income, and owner’s investing capital into the business.

Other Helpful Reports

There are several other financial reports that business owners can use to better understand and operate their business. Many reports go deep into one account’s activity. Below are a few examples and what questions they provoke.

Accounts Receivable Aging: Are customers paying you in a timely manner? Are there any who chronically pay late? Do you need to tighten up your sales process to reduce how long receivables are outstanding?

Accounts Payable Aging: How many bills do you have coming due soon? Are there any disputes you need resolved before you will pay? If you have a lot of bills paid past their due date, what does that say about the health of your company? What are the payment terms for these bills?

Transaction List by Customer/Vendor: Do you have one primary customer or vendor? What would happen if they stopped doing business with you? Who are your top customers? What is your plan to ensure they continue doing business with you?

Transaction List by Product/Service: Which products/services are moving fastest? Slowest? How can you use this data to estimate future sales? Are any of these sales related to external events (ex. seasonality, national economy)?

Next week we will go in depth into the Income Statement. My clients and I pay a lot of attention to this report so I’m certain the article will be beneficial for you too. If you’d like to discuss your business’s financials, you can send me a message via my contact page. Take care and have a great week!