How to Understand the Financial Statements of your Business

As a business owner, being able to understand the financial statements of your business is one of the key skills you need to possess. It helps you get a deeper understanding of the financial health of the business. The information stated in the financial statements is vital for scaling the company, understanding growth opportunities, making better decisions, and much more.

In simple words, financial statements are written records of all the financial activities of your business. Accountants dig deeper into your company’s financial data to understand the financial performance of your business. There are mainly 3 types of financial statement

  • Balance sheet
  • Profit and loss statement
  • Cash flow statement
understand financial statements

Understanding financial statements

Balance sheet  

A balance sheet will help you understand the assets and liabilities and equity of your business. This will get you an idea of the book value of the company. It includes what the company owns and how much the company owes to other parties.

Assets of a business usually include cash, inventory, and other receivables. The long-term asset includes properties, furniture, machinery, etc.

The liabilities of a business include its payables, expenses, loans, etc.

The owner’s equity is simply the net worth of the company. It includes money invested by the stakeholders, share capital, and the company retained earnings.

With the help of a balance sheet, you can calculate the rate of return and evaluate the accounting structure.

 

Profit and Loss statement

A profit and loss statement aka Income statement will help you understand the profitability of your business and how much money you spend on a product. It will also help you analyze financial trends that will help you predict future sales and plan accordingly. Annual and quarterly income statements are made to scale the business activities and financial trends.

Profit and loss statement generally includes:

Revenue is the amount of money the business generates.

Expenses are the amount of money the business spends.

Cost of goods sold (COGS) is the total money spent on manufacturing and selling a product.

Gross profit is calculated by deducting the cost of goods sold from the total sales.

Net income is what’s left after deducting all the costs, expenses, depreciation, interests, and taxes from the total sales.

 

Cash flow statement

It represents the cash inflows and outflows of a business at a given period and its cash position. It gives you a detailed understanding of your cash and how it is gained and spent during a specific period. This will help the business owners to optimize their cash to meet their short-term and long-term needs. Cash is a necessary part of keeping a business up and running. A cash flow statement will help you be prepared to meet your expenses and avoid unexpected cash crunches.

There are typically two types of cash flow.

Positive cash flow indicates the company generates more money than it spends during a specific period. This is what every business aims for. The business owners will have enough money to reinvest in their business, settle debts, and focus on growth. This doesn’t necessarily mean your business is profitable. Sometimes your business might be generating a positive cash flow but the actual cash might be stuck in inventory, receivables, etc.

Negative cash flow simply means the cash flowing out of your business is higher than the cash flowing in during a specific period. It doesn’t always mean your business is at a loss, it can also happen due to a mismatch in your income and expenses. You need to take proper measures to address this issue ASAP

Cash flow statements generally include three segments

Operating activities include cash flow generated by selling goods or services. It includes both revenue and expenses.

Investing activities include the cash flow generated from selling or purchasing assets like real estate, vehicles, patents, etc.

Financing activities include cash glow both debt and equity financing.

You need information from all three financial statements to get the best understanding of the financial position of your business. It will accelerate the decision-making process with the help of accurate data. It is also important if you’re seeking investors or getting loans for your business.

If you need help preparing financial reports or having trouble understanding them, feel free to reach out to us. We provide outsourced accounting services and provide accurate reports that help your business grow.

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