For most small business owners, creating and reviewing your financial statements is not at the top of the “things I enjoy most about running my own business” list. Regardless, financial statements can be powerful tools and are worth the time and effort needed to gain an understanding of them. These statements serve as great tools which provide useful insights on the potential value of new business ventures, and guide your small business’s path. Financial statements are routinely used by decision makers such as investors, creditors and government agencies, and thus can have a big impact on your ability to obtain funding. Even if you outsource your bookkeeping and accounting, a good small business management practice requires understanding how the statements are developed and, even more importantly, how to interpret the information. Here are some tips to help you navigate the realm of financial statements for your small business.
The good news – financial statements are logical tools. Columns need to sum up and accounts need to balance. If you are left-brained, this should be music to your ears. If you tend more on the right-brained side of the equation, think of putting the statements together and the result as pieces to a puzzle and a vision into the future.
Next, let’s go over three of the key varieties financial statements for small businesses:
- Income statements
- Balance sheets
- Statements of cash flow
Income Statements for Small Businesses
The income statement answers the question, “How well did my business perform during the past year?” As a result this tool provides small business owners with a broad view of their financial status.
The income statement shows sales amounts and expense amounts for a period of time. Types of revenue and expenses are listed. (In finance, this is called disclosing revenue and categorizing expenses.) Bookkeepers spend a lot of time properly identifying and assigning expense categories for their small business, and assuring that revenue is allocated to the correct accounts. The difference between the revenue and expenses is net income. This net income is taken from each past period to calculate the retained earnings figure found on the business’s balance sheet. Using these categories, the income statement provides all the details that produced earnings for a small business.
Small Business’s Balance Sheets
The balance sheet answers the question, “What is the financial position of my business at a specific point in time?” It gives you a snapshot of your business for close examination.
The balance sheet is the tool which reveals what you own (your assets) and what you owe (your liabilities). The difference between these two is your small business’s net worth; by having revenue left after paying expenses you create net worth. The balance sheets reveals where the earned money is kept or spent. For example: how much is held in bank accounts, used for the purchase of other types of assets, or spent on equipment and inventory?
Borrowed money is also tracked using the balance sheet. These funds do not add to your small business’s net worth; they are listed on the balance sheet as a liability because they must eventually be repaid. However, using this tool business you can track how borrowed funds were deployed. For example: the borrowed amounts added to assets by increasing the bank account, equipment or inventory.
Inputs for the balance sheet include:
- Bank account balances
- Equipment purchase prices
- Inventory costs
- Amounts paid for buildings and improvements
- Balances owed by customers
- Credit card balances
- Amounts owed to suppliers
- Mortgage balances
- Total owed on lines of credit
- Unpaid payroll liabilities.
The accuracy of your balance sheet inputs results from reconciling the numbers for assets and liabilities, or checking the data with other, independent sources. Examples include checking bank balances on the balance sheet with statements from the bank. Credit card balances are compared to statements from the card company. The inventory balance is compared to an occasional physical count. Loan balances are verified periodically with lenders. Other accounting techniques are employed by bookkeepers to verify balances in accounts receivable and payable.
Statement of Cash Flows in Small Business
The Statement of Cash Flows answers the question, “How much cash did my business generate and spend during the past year?” This statement provides the details on cash in vs. cash out.
The flow of cash is categorized by operating activities, investing activities, and financing activities. The Statement of Cash Flows is a helpful tool in predicting what future cash flows will be, identify potential cash position weaknesses, and preparing for these challenges before they become a problem.
If you’d like more information on the preparation or interpretation of financial statements for your small business, contact us at 619-819-0252.
About the Author
David Heistein, CPA
Dave is co-founder and managing partner at Profitwise Accounting. Dave is a Certified Public Accountant in the state of California, as well as an advanced QuickBooks Pro Advisor and Instructor. As a small business owner, he is dedicated to educating and informing other business owners on bookkeeping and accounting matters.