Financial Statement Analysis for Your Small Business Firm
The income statement, retained earnings, balance sheet, and cash flow statement
Analyzing financial data from your small business allows you, as the owner, to see what's working and where your company could use some improvement. Even if the financial part of the business bores you to tears and you intend to outsource as much of it as possible, you still benefit from understanding it because of the amount of valuable business information the financial statements provide.
The output you receive from your accountant or another financial professional can help you operate your business more efficiently and make better decisions. For example, if your accountant tells you that you made a profit of $1,000 for the year, it helps to understand what went into making that $1,000 and how you can grow profits going forward. You may not have to know as much as the accountant, but it makes sense for you to understand the big picture.
Learning the Basics
Start with the basics to understand and analyze your company's financial position. Maybe you've educated in finance and accounting, but if not, the following provides a short course in understanding and beginning to analyze your company's financial position, by understanding how to formulate each financial statement.
Get up to speed on the financial statements that you or your financial professional will generate for your business firm. These financial statements will help you determine your firm's financial position at a given point in time, as well as over a period of history, and your cash position at any point in time.
Many small businesses fail because the owner doesn't keep tabs on the firm's cash flow and financial position. If you understand financial statements, you can prevent this from happening in your business.
The income statement, also called the profit and loss statement, serves as the principle statement for measuring your firm's profitability over a period of time. You'll develop the income statement in a step-by-step process starting with the amount of revenue your company has earned.
Subtract each item your firm has expensed from the revenue, to arrive at your profit or loss. You can prepare income statements by month if you desire that frequency of information. For tax purposes, you need to have your income statement show information for the entire tax year.
Statement of Retained Earnings
The statement of retained earnings is the second financial statement you prepare in the accounting cycle. After you find your profit or loss figure from your income statement, prepare this statement to find your total retained earnings to date and how much you have available if you choose to pay out money to investors in dividends, if any. Then, transfer your total retained earnings to the balance sheet.
The Balance Sheet
The balance sheet statement shows what you own, called assets, and what you owe, called liabilities. It also includes owners' equity. Your assets must equal your liabilities plus your equity, or owner's investment.
Your liabilities and equity equate to the funds used to purchase your assets. The balance sheet shows your firm's financial position with regard to assets and liabilities/equity at a certain point in time, like a snapshot.
Statement of Cash Flows
Even if your company turns a profit, it may be struggling because you don't have adequate cash flow. Preparing a Statement of Cash Flows is as important as preparing the income statement and balance sheet.
This statement compares between two consecutive time periods of financial data, such as the beginning and end of a month, and shows how cash has changed in the revenue, expense, asset, liability, and equity accounts during those time periods.
The statement divides the cash flows into operating cash flows, investment cash flows, and financing cash flows. The final result shows the net change in your company's cash flows for a particular time period and gives you a very comprehensive picture of the cash position of your firm.
Bringing It All Together
These four financial statements are prepared at the end of each accounting cycle, whether that's monthly, quarterly or annually, and should be prepared in this order. Information from the Income Statement comes from the revenue and expense accounts in the general ledger.
Information for the Statement of Retained Earnings comes from the Income Statement and the dividend account. The Balance Sheet information is taken from the asset, liability and equity accounts in the general ledger as well as from the Statement of Retained Earnings. Finally, the Statement of Cash Flows is prepared using information from all the previous financial statements.