Typically, small business owners can be categorized in three ways: 1) Those who have their financial statements in order and use them to run their business more efficiently; 2) Those who understand financial statements but do not have time to keep them up to date; and 3) Those who do not understand their financial statements and are unsure how to use them to help run their business.
Regardless of which category you fall into, it is never too late to gain a better understanding your business’ finances. In this guide, you will learn about the top three financial statements that every small business owner can use to efficiently operate their business.
Top 3 Financial Statements for Small Business Owners
There are a variety of financial statements that small business owners can use to understand the fiscal health of their business, but the most essential statements are 1) balance sheet, 2) income statement, and 3) statement of cash flows.
1) Balance Sheet
Sometimes referred to as the statement of financial position, the balance sheet is the foundation of financial statements. It illustrates your business’ assets, liabilities, and equity at a given moment, which can help you account for other costs like employee wages and supplies.
What’s it used for? By tracking all these areas, you can understand the “balance” of your business – the approximate cash value. The balance sheet can be used to value stock among internal partners. Externally, parties may ask to see your balance sheet; for example, when potential lenders want to assess your level of risk.
What are the key components within the statement?
- Assets – The value of everything owned by the business, from inventory to machinery to a signed customer contract. There are two types: Current assets (last one year or less; e.g., inventory, cash, or accounts receivable) and long-term assets (longer-lasting assets; e.g., equipment, property, or patents).
- Liabilities – Everything that decreases the company’s value and equity, like what you owe to a creditor or vendor. Liabilities are also divided into current (must be paid within a year; e.g., accounts payable, wages owed, or lines of credit) and long-term (paid over a longer period; e.g., mortgages or deferred tax liabilities).
- Equity – Owner-held equity is the cash value of the company; its assets minus its liabilities. This can be used to calculate the valuation of the company if an owner wants to buy or sell shares.
Equity = (Total) Assets – (Total) Liabilities
2) Income Statement
Also called a profit and loss statement (P&L), statement of income, or statement of operations, the income statement shows the revenues, expenses, and profit or loss of the business over a set period of time.
What’s it used for? The income statement shows the profitability of a business’ current operations. Understanding a business’ income statement stands can help you decide how to operate the business (i.e., expansions or reductions in certain areas) to increase profits. It can also aid decision-making around needs for capital and loans.
What are the key line items within the statement?
- Sales – Revenue earned from selling goods and services
- Cost of Goods Sold (COGS) – The direct costs of producing the goods you sell
- Gross Profit – Sales minus COGS
- General and Administrative Expenses (G&A) – Day-to-day costs of operations like rent, utilities, and insurance
- Earnings Before Tax (EBT) – The pre-tax income of the business
- Net Income – Total revenue minus total expenses, which indicates the profit or loss of the business
3) Statement of Cash Flows
Also known as cash flow statement, this statement provides a detailed view of the cash inflows and outflows over a specific period of time (monthly, quarterly, or annually). It shows the funds that arrived in the accounts of the business, i.e. where the business stands on a cash basis. This differs from the income statement, which shows the income a business has generated or lost on an accrual basis.
What’s it used for?
The statement of cash flows can be used to understand how much cash is available to cover expenses and/or invest in the business. If there are significant differences between the statement of cash flows and the income statement, it can indicate operational issues (e.g. unpaid accounts receivables).
What are the main parts of the statement?
- Operating activities – The cash inflows and outflows from actual operations. This reconciles the net income to the actual cash received or spent by the company during its operating activities.
- Investing activities – Shows the cash flows related to investment, i.e. inflows and outflows from buying and selling long-term assets like property, plant, and equipment (PP&E) or investment securities.
- Financing activities – Cash flows relating to financial areas like the company’s stocks and bonds or bank loans.
Why is it important to keep an eye on your business’ financials?
Mastering these three key financial statements can ensure you know the true status of your business at any point in time. Knowing your business’ financial standing can help avoid surprises, prepare to weather financial storms that may be ahead, and know when to look for outside help (like funding from a small business loan).
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