It’s important to understand the information contained in your financial statements because they can provide you with a health check on how the company is doing financially. Financial Statements give you a snapshot of where money is being generated, and where it’s being spent. There are three main sections to a financial statement which include the Income Statement, the Balance Sheet, and the Cash Flow Statement.
Income Statement:
The Income Statement is a report that shows how much revenue was earned over a period of time, and also shows the expenses that were incurred while earning that revenue. Income statements break these numbers down on a granular level and show the final net profit. This can be used to demonstrate how profitable your business is, which is what a bank or investor will want to see from you to help prove that your business is viable and profitable.
Balance Sheet:
The Balance Sheet provides a statement of the company’s assets, liabilities and shareholders’ equity. They give you a snapshot of what your company owns (assets), what your company owes (liabilities), and what your company’s net worth is, which is what would be left over if your company sold all of its assets and paid off all of its liabilities.
A balance sheet is calculated based on this equation:
Assets = Liabilities + Shareholder Equity
In order for your balance sheet to balance, the combined value of your liabilities and equity must be equal to your assets. This will give you a full picture of your company’s financial health, otherwise known as the total value of the business. It’s important for these to balance because the total value of the businesses assets will have all been funded through the Liabilities and Equity.
Cash Flow Statement:
The Cash Flow Statement summarizes the amount of cash (and cash equivalents) coming into and going out of the business. It also measures how well cash is being generated in order to pay debts and cover operating expenses. There are three types of cash activities that are considered, these include: operating, investing and financing activities.
Operating Activities: This looks at where the money that is being generated from the company’s products and/or services is being spent and used. This can include income tax payments, rent payments, salaries, or any other operating expenses.
Investment Activities: This looks at how much money has been made or spent based on investments. This includes purchasing physical assets and investing or selling securities.
Financing Activities: This is the net amount of funding a company generates within a given time period. Issuing and repaying equity and debt, and paying dividends are all considered financing activities.
It’s crucial to understand your financial statements so that you can have an accurate pulse on where your company’s revenue is coming from and where it is being spent. Once you look at these numbers and understand them, you might realize that too much money is being spent on certain operating expenses based on the amount of income that they’re generating. Not only does understanding these numbers allow you to make adjustments as needed to your operating expenses, it also empowers you with the ability to approach a bank or investor with the information they will want to see in order to consider your company for financing.
