As a business owner, your days are full of many tasks that help ensure your business stays on track. When you do finally settle down at the end of the day, the last thing you want to do is go over your financials- but even so, it’s critical that you monitor your financial statements because they can help you predict whether your business is on track and profiting or if you are on a downward spiral.
Your statements contain information revealing the activities and financial picture of your business over a set period of time. We cannot overstate the importance of making sure your financial accounts are accurate. This is why many Cincinnati-based businesses rely on Orcutt & Co. to help with their payroll, bookkeeping, accounting, and tax planning.
Financial statements are used by shareholders and stakeholders to analyze the financial picture of the business and identify areas where profitability can be increased. In this article, we’re going to explain the 4 financial statements every business owner should know. However, before we get into that, we must first establish the purpose of financial statements and the benefits associated with these statements.
What is the Purpose of Financial Statements?
Financial statements are reports that are made to help shareholders, stakeholders, and owners of a business to understand where they are financially. The information in these reports indicate whether your business is successful or if you are failing, what debt you have that needs to be paid, and where you need to allocate your budget.
What Benefits are Associated with Financial Statements?
There are several benefits associated with financial statements. We will take a look at these below:
Financial Statements Establish the Credibility of Your Business
You can establish the credibility of your company with your financial statements. When you have clear, transparent, comprehensive financial statements, it shows that the business is operating smoothly. This increases the confidence of your clients and investors.
Financial Statements Improve Decision Making
When you have proper financial statements, you can analyze your finances, which allows you to make decisions appropriately. You can determine areas that need to be invested in, costs that may need to be reduced, how you should invest capital, and more.
Financial Statements Show the Health of Your Business
You can use financial statements to evaluate the health of your business. One of the most important factors is cash flow. If you are spending more than you are making, then your company isn’t profitable. If you are making more than you are spending, it’s important to note that your company is profitable- but you must investigate to see how profitable.
4 Types of Financial Statements
As a general rule, there are 4 types of financial statements that all business owners need to be familiar with. Each of these financial statements can stand alone and have different purposes.
First of all, we have the income statement, often referred to as the Profit & Loss (P&L) statement. This statement shows the income versus expenses of the business within a specified time frame. If income is higher than expenditures, your business is profitable- but if expenditures are higher than income, your business is operating at a loss.
There are two forms of the income statement:
The single-step format only requires one subtraction to find net income. This one is much easier to work with.
The multiple-step format requires multiple subtractions when determining net income. The various financials are separated: operating revenues & expenses, non-operating revenues & expenses, and gains & losses. This format will also show your gross profit.
Cash Flow Statement
The second statement we’ll look at is the cash flow statement. This financial statement shows the inflow and outflow of the business for a specified period of time. This statement allows you to estimate money turnover in the future and keeps you accountable to the stakeholders of your business.
There are two things you can use to determine the inflows to your business: from operations and from funding/loans. You can determine outflows based on the costs incurred by the business for investments and operations.
Changes in Equity Statement
The third financial statement we’re going to look at is the changes in equity statement, which provides you with information about your capital for a specified period of time. This report shows you the changes in capital: how much change and the cause of that change.
The transactions you are likely to see on this statement include:
- Net profit/loss
- Proceeds from sale of stock
- Changes in fair value for assets
- Dividend payments
- Changes related to errors in previous periods
- Treasury stock purchases
Typically, this financial statement is presented as a standalone statement but can be added to others as needed.
The last statement we’re going to look at is the balance sheet. The balance sheet indicates your overall financial health for a specified time period. This report lists your assets, equity, and liabilities. This is also often referred to as a statement of net worth or financial position. This statement is based on the basic equation:
Equity + Liability = Assets
As a business owner, you need to be aware of the financial health of your business, which can be determined through financial statements. The four statements listed above are critical for helping you understand your current and future financial condition. Typically, these statements are generated at the end of a period: monthly, quarterly, or annually.
If you have a business in the Cincinnati area, consider contacting Orcutt & Co. We are here to help you with your financial needs, including payroll services, monthly accounting, tax planning, and bookkeeping.