Most small business owners get started to serve customers and to do something they find fulfilling. Not many find that fulfillment in reading financial statements. Yet these statements not only tell them how they’re doing but also suggest actions to promote future success. They are a critical leadership tool to aide in decision making. Show There are three financial statements that every small business owner should understand. They’re the income statement, the cash flow statement and the balance sheet. Here are some keys to using each for business decision-making. Income StatementIt’s also known as the profit and loss statement, or simply the P&L. It shows all the revenue and expense for a specific time period, be it a month, a quarter or a year. It reads from top to bottom. Revenue is the top line, net profit is the bottom line, and different types of expenses and intermediate totals are in between, as follows:
While everyone talks about the bottom line, the most fruitful places to make changes are near the top of the sheet.
The last two expenses, interest and taxes, are areas where a business owner should consider consulting an expert for financial advice. There are ratios that help a business owner gauge financial health.
Ratios vary by industry, so it’s hard to make broad statements about desirable numbers. A professional accountant can help benchmark these against industry norms. Cash Flow StatementIn accrual accounting, income and expenses on the income statement don’t correspond to cash flowing in and out. For example, when a sale is made, the customer owes money and the income statement recognizes revenue. However, a business can’t spend that money until the customer actually pays. The Cash Flow Statement shows how much money was generated from (or used in) operations and how that cash was used for investments and where it came from in the form of financing. Even with a healthy income statement, a lack of cash means trouble in the future. There are two ways to calculate cash flow: direct and indirect. A direct Cash Flow Statement shows changes in cash from three categories:
The direct method is straightforward but requires keeping track of every dollar received or spent. The indirect method starts with net income from the income statement. It then subtracts any factor that added to net income but didn’t produce cash (e.g., an increase in accounts receivable). It adds anything that’s subtracted from net income but didn’t reduce cash (e.g. a decrease in accounts receivables). If cash flow is low or varies greatly from period to period, the business should take action to improve it. Balance SheetA balance sheet lists the company’s assets and liabilities. Assets and liabilities are classified as current and non-current. Current includes cash, receivables, inventory, and debts due within a year. Non-current includes building, major equipment, and long-term loans. A healthy company has more assets than liabilities. Assets minus liabilities equals the third category on the balance sheet, retained earnings. This is the amount of money that has been earned and reinvested. Net profits for the income statement are added to retained earnings. The current ratio is current assets divided by current liabilities. There’s also a quick ratio, which is like the current ratio but excludes inventory from the assets. If this is greater than one, the company can meet its short-term obligations. The balance sheet also shows whether a company has enough overall assets to cover long-term debt. Interpreting Financial StatementsA savvy business owner can learn much from the statements, but a knowledgeable partner such as Avisar Chartered Professional Accountants can really unlock the statements and show a business how to improve its financial position. Avisar specializes in taxes, statements, and consulting for small businesses, entrepreneurs and non-profits. Read our Guide to Understanding Financial Statements for Business Owners for more on how to make the most of your financial statements. Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use. How important is the information from the financial statement in the decisionFinancial statements provide a snapshot of a corporation's financial health, giving insight into its performance, operations, and cash flow. Financial statements are essential since they provide information about a company's revenue, expenses, profitability, and debt.
Why are financial statements important in making credit decisions?They contain significant information about a company's financial position. They can also help companies decide whether to invest in the company or not. Financial statements are important for banks loaning money to businesses. They're also important for businesses selling stock on the stock market.
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