A financial statement is a company’s performance report card. Not only will it provide a precise picture of your company’s financial health, but also acts as a resume that attracts investors. Knowing how to read and draw inferences from a financial statement is an ability every entrepreneur must possess. This article will introduce you to the three major types of financial statements and their significance. After reading this, you will be able to analyze your business’s ability to finance its ongoing operations and repay its debts.
Financial Statement – Three Types
Small business owners need to worry about only three financial statements: Balance sheet, income statement, and cash statement.
Balance Sheet
To put it simply, a balance sheet shows the assets, liabilities, and equity of your company. Your balance sheet must always be “balanced”, as such, assets must be equal to liabilities + equity. If it’s not equal, you will want to go through the entries once again. Let’s get to know what assets, liabilities, and equity mean.
Asset: An asset is any tangible or intangible resource that your company has full ownership of. It could be cash, cash equivalents, accounts, receivable, investments, equipment, land, buildings, etc.
Liabilities: Credit card debts, mortgages, outstanding salaries, accounts payable, notes payable, rent, etc., can be referred to as liabilities. Basically, the money your company is obliged to pay to the debtors.
Equity: Owner’s equity, shareholder’s equity, or simply equity can be calculated by subtracting the liabilities from assets. Contributions made by shareholders, retained earnings, dividends (denoted as a negative number), etc., comprise the equity.
Balance sheets may be prepared whenever needed but studying your company’s balance sheet monthly. quarterly, and yearly will provide you a clear picture of your business’ performance.
Income Statement
Also called the profit and loss statement, the income statement shows your company’s expenses, revenue, and profit/loss during a period of time. It typically consists of:
Revenue: Money that flowed into your company. It could be operating (sale of goods or services) or non-operating (profit from investments, foreign exchange, dividend income, etc.)
Expenses: Money spent by your business. Equipment, utility bills, rent, mortgage payments are some examples.
Cost of Goods Sold (COGS): Refers to the cost of producing the goods. It includes raw material costs and labor charges but excludes indirect expenses like distribution and sales force costs.
Gross Profit: Total revenue of your company excluding Cost of Goods Sold.
Operating income: Profit after deducting operating expenses from Gross Profit.
Pretax income or Earnings Before Tax (EBT): Total revenue less operating expenses.
Net income: Income after tax has been deducted from pretax income.
Depreciation: Decrease in the fair value of assets.
Cash Flow Statement
In a given period of time, the amount of cash that flowed into and out of your company can be easily understood by reading a cash flow statement. This financial statement is categorized into three: Operating activities, investing activities, and Financing activities.
Operating activities report cash flow that arises when your company distributes its goods/services to its clients. You will be able to understand the sources of cash and where they are allocated. The entries you can typically find are net income from the income statement, adjustments to net income such as adding back depreciation and amortization expenses, the difference in working capital, etc. Investing activities detail cash flow from selling or purchasing of assets such as property, vehicles, machinery, patents, trademarks, etc. Financing activities mention the cash flow generated from selling stocks, borrowing from banks, etc.
A cash flow statement thus provides you a clearer insight into the activities that generate cash, allowing you to make informed financial decisions.
Make sure that you don’t rely on just one of the three financial statements to analyze your company’s financial health. But if you are confused and find yourself spending valuable time on learning these concepts, fret not! Connect with Stilz Bookkeeping today to find out how our financial bookkeeping solutions can help your business.