Financial Statements Explained

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Financial Statements 101

As a business owner, have you ever been asked to provide financial statements to a vendor, creditor or investor? Do you dread this question? Have you ever felt guilty because you don’t run routine financial statements? Maybe you feel uneasy to see the results. Don’t be. Regardless of what financial statements say about your company, they are your best resource at evaluating your strengths and weaknesses. It is through these statements that you can better plan; you can’t fix problems or prepare for the future without the right information.

It is important to remember the statement, ‘garbage in, garbage out’. Before you run financial statements, it is necessary that you confirm all information has been entered into your accounting system and that the information has been verified for accuracy.

Below, I have listed the three main types of financial statements. It is important to become familiar with the value that each report provides your business. 

The three main types of financial statements:

1. Balance Sheet
2. Income Statement also called P&L (profit & loss)
3. Statement of Cash Flows

Let’s examine the balance sheet first. The balance sheet is comprised of two sections:

1. Assets

2. Liabilities & Owner’s Equity

The balance sheet shows the basic accounting equation.

Assets = Liabilities + Equity

On the report, the asset section is summed and the liability and owner’s equity section is summed. These two sums must match. When both sections match then it is said the books are ‘in balance’.

This type of report shows the financial position of a business at any given point in time. It is a picture of a business at that moment. When running this report you would select an end date. A beginning date is not selected because this report shows history going back to the very beginning of your business. The report is helpful in determining the financial stability of a company. Creditors and investors analyze a company’s balance sheet before making the decision to start a business relationship with the business or continue an existing relationship.

Next, let’s look at the Income Statement. The Income Statement is comprised of three main sessions:

1. Sales
2. Cost of Goods Sold (COGS)
3. General and Administrative Expenses

Net Income = (Revenues + Gains) – (Expenses + Losses)

This statement is used to see how much a business made and how much it spent for a specified time frame. These reports are typically prepared at the end of each month, quarter and year. When running this report, select a beginning date and an ending date. An income statement subtracts expenses from revenue to get to Net Income. If net income is positive you have a net gain. On the other hand, if net income is negative you have a net loss. This statement can help a business owner determine if revenue or expenses are over or under budgeted. It is also used by creditors and investors. There are two formats to this statement; single-step and multiple-step.

The last statement is the Statement of Cash Flows. The Statement of Cash Flows consist of three sections:

1. Cash Flows from Operating Activities
2. Cash Flows from Investing Activities
3. Cash Flows from Financing Activities

This statement shows cash coming into a business and cash going out of a business during a specified time frame. When running this report, select a beginning date and an ending date. In the simplest terms, think of the activity in a checkbook register. Sections 2 and 3 do make it more complex, but this is a nice way to think of it. Of the three reports, this is the least used report. Many small businesses do not prepare this report on a regular basis. However, it is necessary to provide this report when trying to secure financing. There are two methods used to prepare this report; direct method and indirect method.

As a business owner, you should understand at least the basics of financial statements and how to use them properly. If you are having problems with producing financial statements please don’t hesitate to reach out to me.  I enjoy helping business owners get to the point of relevant and useful financial statements.

Copyright 2014 Christi Rains, Alpha Omega Consulting & Bookkeeping, LLC – http://www.aobookkeeping.com

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