Once your business is up and running, it’s important to know how to read financial statements and understand what they mean. If you do bookkeeping online, programs like Billomat can generate these statements for you to give you an accurate snapshot of how your business is doing financially. The three most important elements of financial statements are the balance sheet, profit and loss statement, and cash flow statement. They each give you necessary information about the overall health and profitability of your business and should be checked regularly to make sure you’re on the right track.
What is the Balance Sheet?
The balance sheet is the report that gives you a big picture view of where your business is at financially at a specific point in time. It weighs all of your current assets against your liabilities and equity, meaning both sides of the statement have the same total. Assets are things like cash, inventory, equipment, and anything else of value that the business already owns. Liabilities are money the company owes, such as bills, loans, and equity (the money left if all assets were sold and liabilities paid off).
Current assets and liabilities are ones which will be converted to cash or paid off within one year, while long-term assets and liabilities are things such as office furniture and longer-term loans, which will remain fixed for some time. The balance sheet includes both of these types of assets and liabilities. Basically, it’s a rundown of everything your business owns and owes, giving you a static snapshot of its overall value.
The formula for a balance sheet is:
ASSETS = LIABILITIES + EQUITY
What is the Income Statement?
An income statement, sometimes also known as a profit and loss statement, gives you a better understanding of whether or not you’ve made money or lost money over a given period; it takes all the revenue your business has earned over a given period and subtracts expenses. In addition to regular revenue and expenses, gains and losses such as interest from savings in a business bank account or losses from theft are also taken into account. Adding all revenue and gains and subtracting from it all expenses and losses will give you your net income. This is the statement you might show to a potential investor or use to determine your taxable income for the year. However, this method of calculating income may not give an accurate picture of whether or not your business is operationally viable; if you have a lot of pending accounts receivable, for example, it will negatively affect your ability to pay your bills in the short term. For a closer look at how your business operates, you’ll want to take a look at your cash flow statement.
The formula for an income statement is:
NET INCOME = REVENUE – EXPENSES
What are Cash Flow Statements?
Cash flow statements give you an idea of the overall inflow and outflow of cash over a specific time; a cash flow statement weighs things such as money received for goods and services against outgoing payments for bills, overhead expenses, and payroll. This can also include investments from shareholders or dividends paid out to shareholders as well. It’s different from an income statement in that it records the points at which cash changes hands and can give you and any potential investors an idea of how you manage your money. Things such as taking out loans or waiting on receivables may not be as evident in your income statement, but a cash flow statement will paint a picture of the financial decisions you’ve made and why. If your business grows quickly and you have multiple orders but need to take out loans for the resources to fill them, this will be evident in a cash flow statement where it may not be as clear in an income statement.
What are Key Performance Indicators?
In addition to these basic statements, you may want to keep track of more specific business metrics, depending on your profession. These metrics, often referred to as Key Performance Indicators (KPI), can give you an idea of how your business is performing in one specific area of interest. For example, if you’re an advertising firm that does creative work in the hopes of winning a contract, you may want to keep track of how much time and money you’ve invested in the proposal phase and which clients ended up paying for your services. Broken down categorically by project type, it may give you an idea of what types of projects you are likely to win in the future. Another important one can be overhead costs – if you have an office with some employees, you’ll want to know how much to mark up their hours when billing to a client, otherwise your business won’t be profitable.
Conclusion: Reading Financial Statements
Keeping track of financial statements and KPIs can go a long way in taking good care of the financial health of your business. Think about it like a doctor’s check-up – it’s much better to catch any problems early before they start to become chronic or life threatening. Although it may not seem like it at first, financial statements can make life a lot easier once you know how to read them.