There are four basic financial statements every business owner needs to know inside and out. If you use common accounting software and do it correctly, the software will be able to generate these reports for any period of time you need to examine. These reports help to:
- Track profits and losses
- Determine total business assets
- Determine equity in the business
- Determine liabilities
- Track changes in the value of the business
- Tracks the business's sources and uses of income and working capital
Balance sheets list business assets and liabilities and show the total owner's equity at any point in time. The balance sheet is also called the Statement of Financial Condition. It is a snapshot showing where the business is in terms of what it has versus what it owes. The difference between the owner's equity and liabilities gives you the current assets of the business. The balance sheet does not show the flow of cash into and out of the company.
Equity represents the total capital or net worth of the company if it sold all its assets and paid off its liabilities.
Liabilities are the debts the company owes for mortgages and loans from banks, unpaid purchases from suppliers, credit card debt and services rendered to the company. Liabilities also include rent, payroll, taxes and obligations to provide goods or services to customers.
Assets include everything the company owns. Current assets are things like inventory to be sold or used to make things or provide services to customers that the company intends to turn into cash within a year. Noncurrent assets include real estate, equipment, trucks and other fixed assets that the company needs to continue doing that would likely take more than a year to liquidate.
Profit and Loss Statement
Also called an income statement, the P&L totals up all income and expenses for a given period of time, typically a month, a quarter or a year. It compares what is going out against what is coming in and tells you if you made any money. Most modern accounting uses an accrual system that includes all expenditures, whether cash or credit and all income earned whether or not it has been actually collected. This statement tells owners how much money they made on paper. It allows the company's directors to adjust what they are doing, trim expenses, delay deployment of new equipment or shut down unprofitable operations in a timely manner. The P&L starts at the top and totals all the company's sources of income. The expense report follows below, deducting expenses from total income until it arrives at the “bottom line” which shows how much money the company did or did not make during the reporting period.
Cash Flow Statement
Profit and Loss Statements tell you if the company made a profit. The Cash Flow Statement tells you whether your business actually generated any cash. The Cash Flow Statement uses and reorders information from the company’s balance sheet and profit and loss statements to show the net increase or decrease in cash for the period it examines. This is important because companies need cash in order to operate.
The Cash Flow Statement examines three types of business activity: operating activity, investing activity and financing activity. It converts net income from accrual-based accounting to a cash accounting model, adding and subtracting changes in non-cash accounts, adding back things which count as income, like depreciation amounts and decreases in accounts payable, but which don’t translate into real cash. It’s possible for a company to be making a paper profit, but have little or no actual cash flow to pay the bills with. This financial report helps the business owner pay attention to the bread and butter parts of the business that create cash flow to cover daily operating costs.
Statement of Changes in Financial Position
The Statement of Changes in Financial Position explains increases or decreases in cash or working capital over a period of time, usually a year. The report is divided into a heading, a section for reporting increases in cash, another for reporting decreases, and a summary of the total change over the year. It shows the sources and uses the business made of working capital or cash and tells you whether you’re better off today than you were last year. The Statement of Changes can use either cash or working capital in its calculations, although accounting regulatory agencies prefer you use cash as the basis for this report.
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