What a Business Financial Statement Can Tell You About the Health of Your Business

When you run your own small business, it can be difficult to keep an objective distance from what you do.

Bills come in, sales go out, you have your day-to-day goals and you watch the curvy line of profit and loss make its inexorable progress throughout the financial year. You have your big one-year and five-year plans, and it takes a serious upheaval for you to reconsider them.

Even if things take a surprising turn – a rough patch or an unexpected boom period – it is human nature to swallow these changes and rationalize the impossibility of them changing the business plan on which you worked so hard. Maybe you assure yourself that things will work out anyway, or that this is no time to take a risk by deviating from your roadmap.

If you alone are responsible for this business plan and for keeping your company afloat, there might not be anyone else around to challenge your views. This is just one reason why maintaining your company’s financial statement is wise business practice. It also means you have a document ready to present to potential investors or collaborators, and that you’ll only need to give it a tune up when the time comes to approach your bank for a loan to take your business to the next level.

But while it’s always pleasant to look at a sheet of healthy, blossoming figures, even when business is booming the actual process of putting your financial statement together can be intimidating. If you started your company because there was a service you were keen to provide, or an idea for a product you were excited to build and sell, then sitting in front of Excel trying to make the numbers add up probably seems difficult – and definitely not a lot of fun.

When you break the document down into its three component parts, however, it starts to seem more straightforward. And once you’ve created your first one, you’ve done most of the hard work – and all that remains is to update it every quarter, or when you are faced with an investment opportunity.

So what are those three components all about?

The first section is your balance sheet, which gives a birds-eye view of your company’s position. The left hand side of this sheet should show your assets – the cash value of the stock and property owned by the company. This is broken down into ‘current’ assets, meaning those that are likely to be converted to cash within the next twelve months, and ‘non-current’ assets, indicating those you’ll hang on to for longer, such as office furniture or vehicles. The right hand side of the balance sheet is your liabilities – the debts you need to pay. Again these are divided into current liabilities (such as a small loan that you will repay within a year) and non-current ones (your mortgage, for example.)

The balance of this section (your assets minus your liabilities) is represented as the ‘shareholder’s equity’ – what you would be left with if you sold off your assets and settled your debts right now.

The remaining two sections provide different ways to look at the current profitability of your business. Section two, your Income Statement, pits your revenues and gains (including sales, service charges, and any interest you might be earning on your business account) against all expenses and losses (equipment, salaries, rent etc.) for a given period, most commonly the past quarter. This gives an indication of the general health and profitability of your business as it stands.

The final section, your cash-flow statement, is a more specific version of the same thing. Here, your profits and losses should only refer to the cash that’s come in or gone out over the same period. It is a more tangible picture of the current state of your business, not taking into account non-cash elements such as depreciation.

To give you a clearer look of just how it functions, you may be interested to take a look at this handy new visual guide – a kind of dissection of the business financial statement. Get your first statement out of the way, and you’ll find you have a much clearer perspective on the current health of your business – and what you need to do to make the next great leap.

G. John Cole is a digital nomad and freelance writer. Specialising in leadership, digital media and personal growth, his passions include world cinema and biscuits. A native Englishman, he is always on the move, but can most commonly be spotted in Norway, the UK and the Balkans.

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Understanding financial statements 101

UNDERSTANDING financial statements is very important if you are looking to invest, become a consultant, work as a CEO or in upper management, or want to start and run your own business. Understanding financial statements will allow you to assess a company’s current financial strength, and determine its profitability and creditworthiness. This article provides an overview of the four key financial statements that you need to understand.

There are four basic financial statements that you need to understand in order to evaluate a company, including the:

  1. Balance Sheet;
  2. Profit and Loss Statement;
  3. Cashflow Statement; and
  4. Statement of Retained Earnings (Owner’s Equity).

1. Balance Sheet

The Balance Sheet presents the financial position of a company at a given point in time. It is made up of three parts: Assets, Liabilities and Equity.

Assets are the economic resources that a company uses to operate its business: e.g. cash, inventories, and equipment.

Liabilities represent the debts of the company, the claims that creditors have on the company’s resources.

Equity represents the net worth of a company, and equals Assets minus Liabilities. Equity holders are the owners of the business.

It is important to notice that Equity is defined as a residual amount. As a rule, companies do not promise to pay back Equity holders. An Equity holder’s investment is more risky than a loan given by a bank because their investment is not guaranteed. In the event of insolvency, bank loans and other debts are repaid before Equity; Equity holders receive the residual amount after all the debts of the company have been paid.

2. Profit and Loss Statement

The Profit and Loss Statement measures the success of a company’s operations; it provides investors and creditors with information to determine the profitability and creditworthiness of the enterprise.

The Profit and Loss Statement presents the results of operations of a business over a specified period of time (e.g. one year, one quarter, one month); it is comprised of Revenues, Expenses, and Net Profit (Loss).

Revenue is the income that is generated from trading, i.e. when the company sells goods or services. Although, it might also come from other sources, for example, selling off a piece of the business or a piece of equipment. It is important to note that, revenue is recorded when the sale is made as opposed to when the cash is received.

Expenses are the costs incurred by a business over a specified period of time to generate the revenues earned during the same period. It is important to distinguish Assets from Expenses. A purchase is considered an asset if it provides future economic benefit to the company, while expenses only relate to the current period. For example, monthly salaries paid to employees for services that have already been provided are expenses. On the other hand, the purchase of a piece of manufacturing equipment would normally be classified as an asset.

Net Profit (Loss) is equal to the revenue a company earns minus its expenses during a specified period of time.

3. Cashflow Statement

The Profit and Loss Statement does not provide information about the actual receipt and use of cash generated during a company’s operations.

The Cashflow Statement presents a detailed summary of all of the cash inflows and outflows over a specified period of time; it is divided into three sections based on three types of activity:

1. Cash flows from operating activities: includes the cash effects of transactions involved in calculating net profit (loss).

2. Cash flows from investing activities: involves items classified as assets in the Balance Sheet; it includes the purchase and sale of equipment and investments.

3. Cash flows from financing activities: involves items classified as liabilities and equity in the Balance Sheet; it includes the payment of dividends as well as the issuing and payment of debt or equity.

4. Statement of Retained Earnings (Owner’s Equity)

The Statement of Retained Earnings shows the retained earnings at the beginning and end of the accounting period. It breaks down changes affecting retained earnings such as profits or losses from operations, dividends paid, and any other items charged or credited to retained earnings.

The Statement of Retained Earnings uses the net income information from the Profit and Loss Statement and provides information to the Balance Sheet. Retained earnings are part of the Balance Sheet under Owner’s Equity.

The general equation for calculating Retained Earnings can be expressed as following:

Retained Earnings (year end) = Retained Earnings (beginning of the year) + Net Income – Dividends Paid