Financial Statements: What business owners should know

Are you a small business owner? Do you know the three common financial statements that are key to the success of your business?

For success, a business owner needs to understand the company's financial position. A financial statement can indicate whether the company is making a profit or having troubles. 

There are three common types of financial statements: the balance sheet, income statement, and cash flow statement. Small business owners should know what these financial reports mean and how to use them to support data-based decision-making in their business. 

What is a financial statement, and why is it important?

Financial statements explain a company's financial performance and profitability over a certain period of time. They are created during financial reporting or the assessment of a company's financial health. Business owners may use another financial report—a statement of retained earnings—less frequently. 

Financial statements will help the business owners to better understand their bottom lines and make more strategic and smarter business decisions. If you have stakeholders - such as shareholders, creditors, and regulators- the financial statements will help them to understand the company's overall financial performance and health. 

Balance Sheet

A balance sheet, also known as a statement of financial position, lists a company's assets, liabilities, and equity balances. It showcases a business's financial position at a particular point in time. 

The three categories are as follows:

• Assets are the resources that generate revenue, or sales, and profits in your business. An asset may be tangible, like a vehicle, or intangible, like a patent or intellectual property. 
• Liabilities are amounts that the business owes to other parties, including accounts payable and long-term debt. 
• Equity is the difference between the assets and liabilities. This is the true value of the buisness. Equity includes common stock, additional paid-in capital, and retained earnings. 

The formula of the balance sheet is Assets - Liabilities = Equity. The double-entry accounting system requires the accounting equation to stay in balance as transactions post. The balance sheet accounts calculate working capital and other important ratios that will help you better understand the financial health of your company. 

Income Statement

The income statement shows the company's revenue and expenses for a period of time. It provides information relating to returns on investments, risks, financial flexibility, and operation capabilities. Most companies produce multi-step income statements, which document how a firm produces net income. In a multi-step income statement, you will first find your gross profit and then your operating income for a period of time. 

Sale, cost of goods sold (COGS), gross profit, and operating expenses, as well as operating income, which you generate from day-to-day business activities, are all input for the income statement. Non-operating income is inconsistent and unpredictable, so you can't rely on it to produce annual profits. Your business must produce a majority of its net income from operating income activities because operating income is sustainable. 

Cash Flow Statement

The cash flow statement, also known as the statement of changes in financial position, documents a company's cash inflows and outflows. Cash flow is broken up into three categories: 

• Operating activities indicate the sources and uses of cash related to a business's daily activities. Operating activities include cash from customer sales and inventory. A company should produce most of its cash inflow from day-to-day operations that it can sustain over months and years. 
• Investing activities refer to cash activity related to buying and selling assets like machinery, equipment, and vehicles. 
• Financing activities occur when a company earns money from a stock or bond issue. This financing category also accounts for cash repayments to investors. 

Most of the cash activity in a business takes place in the operating category. When generating the cash flow statement, identify the investing and financing reactions first. All remaining cash activity is in the operating category. 

4 Common Mistakes on Financial Statements

Making one of these common mistakes can affect the accuracy of your financial statements and business decisions 

1. 1. Your don't include comparative data.
2.     Including prior-year, prior-month, or budgeted amounts makes it easier to see if actual amounts meet expectations. 
3. 2. You don't reflect reality. 
4.     Financial statements should always reflect the true financial condition of a business. Consider having your financial statements reviewed by a third party to identify inaccuracies. 
5. 3. You don't revise procedures to reduce discrepancies. 
6.     If you identify an error or discrepancy in your financial statements, take the time to revise your accounting procedures. 
7. 4. You don't audit your financial statements. 
8.     Financial statements are only beneficial if they are accurate. Don't generate a financial statement just for the sake of having one. Read the statement, address any discrepancies, and use it to understand your business's financial health better. 

Accounting software like QuickBooks Online can make producing these statements easy for business owners. 

Do you know how to create financial statements for your business? Do you have a program like QuickBooks Online to track all your company's revenue and expenses in one location and make the statements for you? Would you like a bookkeeper to manage all that and have the statements prepared for you monthly so you can make the most data-driven decisions for your business? 

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