If you are a small business owner, you may feel overwhelmed about how to ensure that your finances are tracked and recorded correctly. Financial statements are an official and formal record of your company’s financial activity. The most important financial statements your company will have are your balance sheet, income statement, and cash flow statement. These three financial statements work together to provide an overview of your company’s current financial status and forecast future opportunities for your company.
A balance sheet, also known as a statement of financial position, provides a snapshot of your company’s financial status at a specific date or period in time. A balance sheet will show the business’s assets, liabilities, and any shareholder equity, if applicable, during the month or quarter in question. The basic formula displayed in a balance sheet is that assets equal liabilities plus shareholder equity. Additionally, the following are some definitions of financial terms often used in balance sheets:
- Assets – Anything of value that is owned by a company, which is either cash or may be converted into cash
- Current assets – Anything a company expects to convert into cash within one year
- Noncurrent assets – Anything a company does not expect to convert into cash within one year
- Liabilities – Amounts of money that a company owes to another (also known as debts)
- Current liabilities – Amounts of money (debt) that a company expects to pay off within a year
- Long-term liabilities – Amounts of money (debt) that a company expects to pay off or are due in over one year
- Shareholder equity – The money that would remain if a company sold all of its assets and paid off all of its liabilities (debts). It is important to note that this excludes any money used to start the business (capital stock) or any profits that were kept from previous years (retained earnings)
In order to create a balance sheet, you will need to list all your company’s assets on one side of the page. Make sure to include any cash in bank accounts, the current value of company equipment that your business owns, the value of any current inventory, and any other assets. Valuation of assets can be a challenging endeavor, especially when some assets will depreciate over time. If you have assets that may be considered hard to value, or may depreciate, you may consider consulting an expert to help you make those financial determinations.
On the other side of the balance sheet, you should list your company’s liabilities, which are debts or financial obligations. Some types of liabilities include credit card balances, bank loans, accounts payable, or any other type of money that is owed by your company.
At the bottom of your balance sheet, you will calculate your total assets, total all your liabilities, and then subtract your liabilities from your assets to determine the owner equity in your company. Oftentimes, this may be a negative number, especially for newer businesses. However, creating a balance sheet can help you keep a solid handle on the overall financial health of your business as it grows.
An income statement is also called a profit and loss statement (“P&L”). It shows, in detail, all the revenue, expenses, incomes, and losses for your business over a specific period of time. Your business’s tax return will use a modified form of this income statement to calculate your potentially taxable income. Essentially, your income statement is the following formula:
Profit = Revenue – Expenses
Here are some definitions of commonly-used financial terms in income statements.
- Revenues and Gains – Revenues and gains refer to all the income earned by your company during a period of time. This can include interest in a bank account as well as income generated from sales of goods or services.
- Expenses and Losses – Expenses and losses report all the financial outgoings of a business during a period of time. This may include salaries, purchases of equipment, payments to freelancers, rent payments, software fees, or even expenses relating to a lawsuit or judgment against the business.
You should first total up all revenue generated from your business, then total up all your expenses and losses. A well-maintained income statement, prepared monthly, can help you have an accurate picture of your current finances, as well as where your company’s financial health is headed. Additionally, taking the time to examine these income statements can help you as a business owner decide if you should focus on certain profit lines that are more profitable, or remove some unnecessary expenses. Finally, having these income statements will allow any potential investors the opportunity to assess the level of risk involved in extending credit or venture capital to your business.
A cashflow statement shows the inflow and outflow of cash and the ending balance during a specific period of time. While income statements help determine if your company made a profit, a cashflow statement will tell you if your company actually generated or lost cash during a specific period of time. Oftentimes, these cashflow statements are created on a quarterly basis. However, they can be prepared for any period of time. Additionally, even if you only prepare a cashflow statement quarterly, you should indicate month to month changes within that statement so that you have an accurate picture at the end of a quarter.
There are three sections within every cashflow statement: operating activities, investing activities, and financing activities. The following are definitions of the financial terms used on most cashflow statements.
- Operating Activities – The normal activities carried out by a business that create either inflows or outflows of cash. This will include your net income and losses, minus your regular business expenses. This is an important calculation because it will provide an accurate financial picture of the cash your company generates before any additional costs associated with either investing or financing are taken into consideration.
- Cash Inflow – The revenue from the sale of goods or services by your business.
- Cash Outflow – Payments to employees in the form of salaries and wages, and any other business expenses paid.
- Investing Activities – Changes in cash due to the sale or purchase of property, equipment, plants, or any other long-term investments. Cash inflow or cash outflow as it relates to investing activities concerns the sale or purchase of company property.
- Financing Activities – These activities reflect and report cash level changes from the purchase of a company’s own stock, or the issue of the company’s own bonds, as well as any payments to shareholders of interest and/or dividends. Cash inflow or cash outflow as it relates to financing activities is either the sale of equity securities or the issuance of dividends to shareholders.
A cashflow statement will show how your company spends and earns money over a period of time. Investors typically scrutinize a company’s cashflow statement because it will provide a comprehensive overview of how the business operates, how it makes money, and how you, as a business owner, make choices regarding your business operations.
More businesses fail due to cashflow issues than for any other reason. In fact, even if your business is very profitable, it may still have serious cashflow challenges that can lead to the downfall of your company. Your income statement will help you understand if you have made a profit, but it does not reflect any missing or delinquent payments, or help you, as a business owner, determine if you actually generated enough cash to keep your company in business and profitable.
Cashflow statements may be updated monthly; however, many business owners choose to update them weekly or even daily to ensure that they have an accurate representation of their business finances. Many different types of accounting software programs, such as QuickBooks or LivePlan, can help you create dynamic reports for your business and assist you with quickly updating your cashflow statements.
Other Important Financial Documents
While the balance sheet, income statement, and cashflow statement are the most important financial statements you need to create for your business on a regular basis, there are some additional financial documents you should consider preparing.
- Sales Forecast – Consider creating a spreadsheet that will project your sales over the course of three years. You may create different sections for different types of sales, and then create an estimation of what you believe your company will sell, including the pricing of your products and the cost of sales, which equates to the gross margin: sales minus the cost of sales. Creating this sales forecast can help you determine if you are on track in your business for your company goals.
- Financial Budget – Just like your personal household budget, a business must also have a financial budget. As a business owner, you will need to determine how much it will actually cost to make the sales you have set as a goal in your sales forecast. You will need to consider everything, from your payroll, rent, advertising, and promotional expenses, to your interest and taxes. Many of these numbers will be estimates, but it is always best to start a financial budget, then make it more accurate over time.
Understanding and Creating Your Financial Statements
As a business owner, you should take the creation and examination of your monthly financial statements seriously. These financial statements are a snapshot of your business’s financial health and can help you make the most informed decisions about your company and provide insight for any possible investor in your business. Immersing yourself in these financial statements can seem daunting, but it is truly the best way for you to genuinely understand how money flows in and out of the business and help you gain the context you need to ask the right questions, make the best decisions, and provide the correct answers to possible investors or stakeholders.
Professional Bookkeeping Services
If you are a business owner, one of the best decisions you can make is creating monthly financial statements for your company, and truly understanding how they represent the financial health of your business. Contacting a financial advisor and professional bookkeeper can help you understand exactly how you should create these monthly financial statements and establish a protocol for creating accurate financial statements and documents that will be the foundation upon which you make your future business decisions. Never leave the creation of these financial statements to chance. Your business may succeed or fail depending on how you create and interpret these important financial statements. Ultimately, the responsibility regarding understanding how to create these documents rests upon you, the business owner.
At Anderson Advisors, our experienced and skilled team offers professional bookkeeping services and would welcome the opportunity to help you develop a plan to create monthly statements for your business and interpret the data, empowering you to make the wisest financial decisions for your business. Call our office at 866-896-6141 for a free consultation today.