If you are starting a small business, the best thing you can do is learn how to read a financial statement. You may hire an accountant to prepare your financial statements for you, along with doing your income taxes and other financial chores. You, as a business person, have to be able to provide that accountant with the information they need to develop the financial statements for your company. You can’t do that unless you know how to read them.
You also need to be able to read your financial statements in order to be able to keep track, on an ongoing basis, what is happening financially with your company.
It is likely that you will use some sort of spreadsheet program to keep track of your income and expenses. This allows you to give your accountant a comprehensive source of income and expenses. Your spreadsheet program may generate financial statements for you. Take a look at your software package and see if it does.
The basic guide to financial statements in this article will assist you in learning to read and understand the financial statements that you will need to generate for your company monthly, quarterly, and yearly.
Learning the Basics
Many small businesses hire a financial professional to generate financial statements. Get up to speed on the financial statements that your financial professional generates for your company. 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 time, and your cash position at any point in time.
Many small businesses fail because the owner doesn't keep track of the firm's cash flow and financial position. If you understand financial statements, you can prevent this from happening in your business.
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 $1,000 and how you can grow profits going forward. You may not have to know as much as the accountant, but it makes sense for you to understand the big picture.
The Income Statement
The income statement, also called the profit and loss statement, serves as the principal statement for measuring your firm's profitability over a period of time. You'll develop the income statement in a step-by-step process starting with the amount of revenue your company has earned. From sales revenue, you will subtract all your expenses in a format such as that illustrated in the following template. The larger and more complex your company grows, the more complicated your income statement will be.
|INCOME STATEMENT (for the year ended ____________)|
|Total Sales Revenue||$|
|Earnings Before Interest and Taxes||$|
|Earnings Before Taxes||$|
The Statement of Retained Earnings
You usually only prepare a Statement of Retained Earnings, also called a Statement of Stockholder's Equity, if your company is publicly-traded and issues dividends to its shareholders. It is the second financial statement you prepare in the accounting cycle. Retained earnings are the portion of net income that is plowed back into the company and used for growth. The remaining portion of net income is paid out as dividends. The retained earnings figure is then transferred to the balance sheet.
|STATEMENT OF RETAINED EARNINGS (YEAR)|
|AMOUNT||RETAINED EARNING||TOTAL EQUITY|
|Balance Previous year||$||$||$|
|Issuance of common stock|
|Balance Current Year||$||$||$|
The Balance Sheet
The balance sheet statement shows what you own, called assets, and what you owe, called liabilities. It also includes owners' equity, which comes off the Statement of Retained Earnings in the previous section. Your assets must equal your liabilities plus your owner's equity.
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.
|BALANCE SHEET For the Year Ended December 31, ______|
|Marketable Securities||Notes Payable|
|Accts Receivable||Taxes Payable|
|Prepaid Expenses||Mortgages Payable|
|Total Current Assets||$||Long-Term Payables|
|Plant and Equipment||Long-Term Liabilities||$|
|Total Fixed Assets||$||Total Liabilities & Stockholder's Equity||$|
The Statement of Cash Flows
There is one crucial fact to understand about small businesses. They simply will not be able to stay in business without cash. One of the most important year-end statements becomes a small business's Statement of Cash Flows. The Statement of Cash Flows has three sections: Operating Activities, Investing Activities, and Financing Activities. The Statement of Cash Flows allows the business owner to see exactly where their money is being spent and received. Here is a template you can use that, at least, gives you a starting point.
|STATEMENT OF CASH FLOWS FOR YEAR _____________|
|Change in Accounts Receivable||$|
|Change in Inventory|
|Change in Accounts Payable|
|Net Cash Provided by Operating Activities||$|
|Sale of short-term investments||$|
|Cash used to acquire fixed assets|
|Net Cash Provided by Investing Activities||$|
|Change in notes payable|
|Net Cash Provided by Financing Activities||$|
|Net Change in Cash||$|
|Cash at Beginning of the Year||$|
|Cash at end of the Year||$|
The Bottom Line
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.