Learning the ins and outs of financial statements can be a new and at times difficult experience – particularly when you're spending most of your energy concentrating on providing superior service to your customers or getting a new business off the ground.
However, learning how to read your financial statements and use them to plan for your business's future is essential to being successful for years to come.
It's important to have a great accountant by your side, but it's also up to you to understand the documents and numbers. Every business owner should know the three most common and necessary financial statements: the balance sheet, the income statement, and the cash flow statement.
The balance sheet
The balance sheet lists the company's assets, liabilities, and equity. Assets are what the company owns, such as physical property, equipment, and inventory. It can even include the value of trademarks and patents. Cash is also an asset of any business.
Liabilities cover money the company owes to other people and businesses, such as loans, inventory, taxes, and salaries not yet paid. They also include obligations to customers for goods and services not yet provided.
Equity is the net worth of the business, which means it's the money left after the company has paid its liabilities.
The income statement
The income statement, which is also called the profit and loss statement, lists the sales of the company minus its expenses for a specific period of time, such as a year or quarter. The document will begin with sales then deduct costs and operating expenses associated with earning revenue. It will end by providing the "bottom line," i.e. the gross amount the company earned in the period.
The statement will also take into account depreciation, which is deducted from the gross profit. Next, interest income and expenses are added or subtracted as well, and finally income tax is deducted to give you your net profit or losses.
The cash flow statement
This document rounds out the three basic financial statements and provides you with information on the cash moving into and out of your business during a specific time period. This information is crucial to understanding why you may not have money in the bank but your income statement says you made a profit. Making a profit shouldn't be your only consideration. You also need cash on hand to purchase inventory and pay workers.
Having these three statements for your business – and knowing how to read them – will allow you to measure your growth and success. With the figures provided in the statements, you can accurately price your products and services, track your short- and long-term profitability, and even decide whether it's time to take on more debt in order to expand or to hire a new worker.
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