Financial reporting can be quite a chore for small business owners. Unless you are a CPA, accounting probably isn’t your area of expertise. But financial statements are important tools for making business decisions.
The three most important financial statements are balance sheets, income statements, and cash flow statements. Business owners rely on them to make business decisions, and accountants use them during tax preparation. Lenders look at these documents to determine whether a company qualifies for financing.
A balance sheet provides an instant picture of a business’s financial situation at a particular moment in time. Also called a statement of condition or a statement of financial purpose, this report shows an organization’s assets (what it owns), liabilities (what it owes), and net worth (the difference between the two). It provides a breakdown of current assets and fixed assets, as well as current liabilities and fixed liabilities.
The balance sheet also shows how much equity you (and partners if you have any) have in the business.
An income statement shows all actual income and expenses incurred for a particular period of time, such as a month, a quarter, or a year. Also called a profit and loss statement, a P&L, or a statement of operations, this report’s most important numbers are a company’s gross profit, total expenses, and net income. These figures come from reported sales, cost of goods sold, a breakdown of expenses, operating income, other income, and income taxes.
Cash Flow Statement
A cash flow statement shows how much actual cash enters and leaves your company’s coffers for the time period covered, including all operating activities, investing activities, and financing activities. Incoming cash appears in different categories, such as sales, cash from vendors, interest received, owner contributions, any borrowed money, or miscellaneous sources. There are categories of use for outgoing cash such as payroll, inventory, operating expenses, equipment, capital expenditures, debt, and distributions to owners.
The cash flow statement is an internal document that shows exactly how much cash you need to cover expenses during a given time period.
Tips for Accurate Statements
- Good bookkeeping is the key to accurate financial statements.
- Resist the temptation to delay recording information—you risk forgetting the details of your expenditures and income.
- Use financial software to maintain your company’s financial information and automatically generate financial reports.
- Link your financial software to your company’s checking account. Most major credit unions or banks offer online services that let you download current account information directly into the software.
How to Use Your Financial Statements
Though income and cash flow statements sound similar, there are important differences. The income statement shows actual income and expenses incurred during a particular period, while the cash flow statement shows the expenses paid during that time period.
An income statement also shows interest, depreciation, and amortization expenses, all of which reduce your net profit but do not appear as cash paid on a cash flow statement.
Income and cash flow statements are invaluable for forecasting future expenses. Information about actual expenses paid can help you predict what your future expenses will be, which in turn allows you to create budgets. But bear in mind that income and expense predictions are just that – predictions. Be sure to update your financial statements regularly to monitor how closely your predictions reflect your company’s fiscal reality and adjust your budget as needed.