You might think that financial statements are only for big businesses or corporations. But, your small business can benefit from creating financial statements from your small business bookkeeping information. What is a financial statement?
What is a financial statement?
A financial statement is a collection of your business’s financial information. Use statements to organize information and form conclusions about your business’s financial health. Statements include line-by-line items as well as total amounts of business transactions. But, various types of statements report different information.
There are three main statements to use for your small business: the balance sheet, income statement, and cash flow statement. Use each of these statements to gain insight into your business’s finances.
An income statement is a summary of your business’s profits and losses during a period. After choosing a time frame, break down revenue and expenses on the statement.
The income statement is also called a profit and loss statement for small business. Prepare the income statement monthly, quarterly, or annually.
What the statement tells you
The income statement shows how well your company is doing over time. It measures the profitability of your business. You can see which sales items are the most and least profitable. Also, look for any expenses you could reduce or eliminate.
Use the income statement to find out if you are over or under your business budget. The statement shows how much cash you have left over after expenses. The leftover cash can be used to expand your business, pay yourself and other owners, and pay debt. If you do not have leftover cash, look for ways to adjust your budget.
Investors, lenders, and vendors often want to look at your business’s income statement. These individuals assess the level of risk involved in working with your company.
The income statement doesn’t show overall financial health, money you owe or owed to you, or assets and liabilities.
Parts of the income statement
Sales include the amount of revenue you generate through regular business activities. You make sales by selling goods and services. Record sales as the total revenue minus returns and discounts.
The cost of goods sold (COGS) is the total expense directly related to producing a good or performing a service. The COGS includes raw materials and direct labor expenses.
After listing the sales and cost of goods sold on the income statement, note the gross profit. Gross profit is the sales minus the cost of goods sold.
Operating expenses are the everyday costs you incur through business operations. Operating expenses include salaries, marketing costs, travel expenses, rent, utilities, and depreciation.
Under the operating expenses, list the business’s total expenses. To find the total expenses, add the COGS to the operating expenses.
Next, write the net income before taxes. The net income before taxes is the gross profit minus total expenses.
Now, list the income taxes that you owe to government agencies. And, include interest.
At the bottom of the statement, write the net income. The net income is how much money you have left after paying all expenses, including income taxes. Subtract the amount you pay in taxes from the net income before taxes.
This is what an income statement looks like:
The balance sheet summarizes important financial information on a specific date. It gives you a snapshot of your financial health. Usually, you create a balance sheet at the end of a period, such as monthly or quarterly.
What the statement tells you
Use the balance sheet to make decisions about spending and expanding your business. The balance sheet can also help with business debt management. And, it gives an idea of how efficiently you turn assets into cash.
You can see your business’s stability and liquidity on the balance sheet. This information helps you determine your ability to finance growth without outside funding.
Use the balance sheet to find your business’s net value. Your small business valuation is important if you want to incorporate or sell your business. Often, lenders and investors want to see your balance sheet. They use the statement to assess the level of risk involved in working with your business.
Parts of the balance sheet
There are three parts to the balance sheet: assets, liabilities, and owner’s equity.
Assets are items of value that your business owns. For example, bank account balances, petty cash funds, accounts receivable, and inventory are assets. Also, include property such as buildings, equipment, and computers that you own. List the assets on the left side of the balance sheet.
There are two kinds of assets on the balance sheet. Separate the assets by these categories:
- Current assets can be turned into cash quickly, like inventory.
- Noncurrent assets are not turned into cash quickly, such as a business vehicle.
Liabilities are what you owe to other individuals, businesses, organizations, and government agencies. They include debts, loans, and outstanding credit card balances. List liabilities on the right side of the balance sheet.
There are two kinds of liabilities on the balance sheet. Separate the liabilities by these categories on the balance sheet:
- Current liabilities are usually paid off quickly, such as accounts payable.
- Noncurrent liabilities are not paid off quickly, like a long-term small business loan.
Owner’s equity is the money left over after paying debts. If your business has more than one owner, the owner’s equity is split according to the amount of the company that belongs to each owner. You can find the owner’s equity by subtracting liabilities from assets.
Assets – Liabilities = Owner’s Equity
List the owner’s equity on the right side of the balance sheet, under the liabilities. Then, list the total owner’s equity and liabilities. The total owner’s equity and liabilities should equal the total assets.
This is what a balance sheet looks like:
Cash flow statement
What is a cash flow statement? In short, the cash flow statement measures money flowing into and out of your business during a period. You can use the cash flow statement to see how much cash you have on hand. Update the cash flow statement daily, weekly, or monthly.
What the statement tells you
Timing when you receive cash and when your expenses are due is crucial to your financial health. The cash flow statement shows if you have enough cash on hand to keep your business running.
The cash flow statement helps you manage incoming and outgoing funds. The statement can also tell you if you need to secure more financing or manage expenses better.
Parts of the cash flow statement
You will need to know all the cash inflows and outflows to create a cash flow statement. Separate cash into three categories: operational, asset investments, and financing. To find the total cash balance on your cash flow statement, add the operational costs, investments, and financing.
Operations + Investments + Financing = End Cash Balance
The operations section shows incoming and outgoing cash related to your products and services. Include money generated through sales. And, include expenses incurred through regular business operations.
The investments section includes cash from buying and selling long-term assets. Long-term assets stay in your business for longer than one year. They might be property, equipment, and mortgages.
The financing section shows cash you received from a loan, line of credit, or other capital. And, it lists money you paid to lenders, investors, and vendors.
To make a cash flow statement, begin with your starting cash balance. Then, include cash inflows and outflows for the operations, investments, and financing sections.
This is what a cash flow statement looks like:
Applying statements to your small business
At first glance, creating and reviewing financial statements can be a little scary. But, as a small business owner, it’s your job to keep track of your company’s financial health. Statements give you a clear view of the direction your business is headed. And, they help you plan your next moves to push your company forward.
You can make smart decisions by looking at your financial statements. For example, you can use statements to check that you price products or services effectively.
Financial statements help you keep information organized. You don’t want to report incorrect information to the government when you file a small business tax return. Errors on government forms can lead to fines, fees, and other penalties.
The more you check your books, the more likely you will report accurate information and avoid IRS audit triggers. If the IRS audits you, your statements help prove you reported accurate information.
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