Financial statements provide insight into the overall health of a company. As a small business owner, you’ll want basic working knowledge on how to read and analyze financial statements. When you understand the key components of financial statements, you can make strategic business decisions as well as identify challenges and opportunities within the business. If you’re considering a bank loan, the lender will require these documents as a window into the company’s financial position.
Regardless of whether you have an accounting team, or you do the books yourself, we’re highlighting the three financial statements that all business owners should be able to interpret. We believe that when you can manage your money wisely, you’re actually setting yourself up to be more successful.
The balance sheet gives a clear view of assets, liabilities and equity at a single point in time. Assets are anything that the company owns of value. This could be cash, accounts receivable and inventory. Liabilities include any debt that is currently owed — bank loans, rent and utility payments and taxes. Equity is the amount owned by the company’s shareholders. The main formula you need to understand a balance sheet is:
Assets = Liabilities + Equity
When you can analyze the balance sheet, you’ll be able to recognize any potential warning signs within the business. Use fundamental analysis to gain a better understanding of the company’s value and determine things like how much working capital is available, how quickly customers are paying their bills, the company’s debt to equity ratio and operational efficiency. Knowing these metrics can help you make informed business decisions.
Also known as the profit and loss (P&L) statement, this document summarizes a company’s revenue minus your costs and expenses. It offers insight into financial trends, like when costs are highest and lowest and the overall profitability of the business. An income statement shows the following:
- Revenue: total income during a period of time
- Cost of goods sold (COGS): how much it costs to produce goods or services that you offer your customers
- Gross profit: this is what you get when you subtract your COGS from your revenue
- Expenses: also known as operating expenses, this is what it takes to keep your business running —rent, equipment, employee salaries, marketing and general maintenance fees
- Earnings before interest, taxes, depreciation and amortization (EBITDA): a metric to measure the profitability of a company
- Taxes: how much the company has paid in taxes
- Net profit: the literal bottom line on an income statement, as well as the figurative bottom line — the final profit for the business
Ultimately, the income statement tells the financial story of the business over a given period of time in relation to the company’s expected performance. As a small business owner, you’ll be able to see where you can set goals to improve (example: cut operating expenses) and uncover areas where you’re exceeding your goals.
Cash Flow Statement
The cash flow statement is a snapshot of every incoming and outgoing transaction within your company. It measures how well you can generate cash to pay back debt and your ability to support operating expenses. This is crucial to knowing your liquidity and what you can (and cannot) afford. Cash flow statements show changes in assets, liabilities and equity to measure your company’s performance. They also allow you to create cash flow projections for the future, helping drive wise business decisions.
Comprised of three main sections, cash flow statements account for cash from operating activities, investing activities and financing activities. It should be noted that cash flow is not the same as profit. Both are important metrics in evaluating a business and should be reviewed in conjunction for a holistic view of the business.
A Complete Picture
All three of the documents listed above work in conjunction to paint a clear picture of a company during a set period of time. As a business owner, you’ll be better equipped to build a successful business strategy if you have working knowledge of your financial statements. Even if you’re not a “numbers person,” it’s a good idea to review your financial statements regularly to dig into problems, ask tough questions and recognize successes.