Understanding Financial Statements for Your Small Business
Posted by James Cooper on Wed, Apr 13, 2011
Understanding financial statements is a necessary skill all small business owners need to have. You must know; 1) What the numbers mean on the page, 2) How to calculate further ratios from the raw data, and 3) what to do to affect your results in the future. Let’s look at the basics;
What are the Financial Statements?
Financial statements are simply a standardized way of recording the financial health and situation of a business. This can be a sole proprietorship, partnership or company. Normally you will find 4 financial statements;
- Income Statement: (Also known as Statement of Financial Performance or Profit & Loss (P&L)) The Income Statement records all revenue
- Statement of Financial Position: (Also known as the Balance Sheet)
- Statement of Changes in Equity: (Also known as the Equity Statement, or Statement of Owner's Equity or Statement of Retained Earnings)
- Statement of Cash Flow: (Also known as the Cash Flow Statement)
In small business, often owners only have the complete financial statements done once a year by their accountant as part of legal tax filing requirements. While you might not need the level of detail that you get from your accountant.
What are Management Reports?
Management Reports are simply the key financial reports the management (YOU) look at and review each month taken from your in-house accounting system. I recommend at the most basic level you review the following each month;
Most small businesses should have some sort of in-house accounting system, it doesn’t matter if it is online, on your desktop or on your company server, it’s likely to be the basic tool you use for creating invoices, managing accounts receivable, and entering purchases and expenses into. Even the most basic software have a reporting function. Get familiar with it!
(We’ll provide links from this article to separate articles with all the detail you need on what the income statement is and what the statement of financial position is, due for release in the next few days)
How do they fit together, how are they linked?
The Income Statement tells you how you are performing… e.g. are you making a profit or a loss from your activities (buying & selling goods and services) on a month by month basis. Do you make more money than you spend basically?
The Statement of Financial Position tells you the how your performance (making a profit or loss through your business activities) has impacted your financial position from the start of the month to the end of the month. E.g. if in March you made a loss of $10,000, then this will be reflected on not only on the Income Statement as a loss of $10,000, but very importantly on the Statement of Financial Position by adjusting your Net Assets position likely by $10,000.
Net Assets is simply the difference between your total assets (bank account funds, account receivable, etc) and your total liabilities (money you owe banks, or accounts payable, etc). It’s likely that the $10,000 loss will either will come out of either your bank account or be added to your accounts payable as money your owe to other people.
So, the financial position of the company got worse by $10,000, damn it! You’ll now need to work hard to make profit of $10,000 in the next month or just to get you to the same financial position as you were before. This is why it is vital for all small business owners, to look at the in-house management reports, at least of the Income Statement & Statement of Financial Position, every month.
Calculating Financial Ratios
Learn how to calculate financial ratios from your financial statements, why they are important
Making Informed Smart Business Decisions
Learn how to make quality business decisions from your monthly Strategic Financial Review
Action Points
- First, bookmark this page and return over the next few days to access links for further reading on this topic. Or subscribe to this blog by entering your email in the Subscribe by Email field on the right hand side or by RSS
- Second, set a monthly financial review meeting for the second Tuesday of every month (at the latest, make it the 1st of the month if you can!). You and your team must commit to having your financial statements completed by this date, no excuses each and every month.
