To make financial decisions for your business, you need a tool that can provide you with the right information. A tool that tells you exactly what is going on, so you can decide what to change and what to keep as-is. Financial statements do just that - provide a snapshot of your business finances at any given period. Their purpose is to provide you, the business owner, a quick overview of your business's financial health and measure business performance.
What are financial statements?
Financial statements are divided into three main types:
An income statement is a measure of your business's financial performance. It gives you an overview of your business earnings over a period of time.
Your balance sheet is a picture of the financial health of your business. It outlines what a company "owes" and "owns."
Cash flow Statement
The cash flow statement is a look at your cash management. Cash "inflow" and cash "outflow."
These 3 Financial Statements are used as filters to segment your business data. Each statement provides insight around a specific aspect of your business, and collectively the three financial statements paint an accurate picture of your business's health and financial viability.
Why Are Financial Statements Important?
Financial statements enhance your business decision making. They show a direct correlation between business decisions and business performance, taking you beyond the linear thinking behind "Revenue - Cost = Profit." Once you start making important business decisions using financial statements, there's no going back.
For example, you want to invest in this new piece of equipment or other long term assets. Your equipment costs $50,000 and will make you an additional $15,000/month in revenue, of which $5000/month is profit. This is great. In 10 months, it would have paid for itself, and after that, it's all profit. The additional revenue it generates will pay for any maintenance it needs. Wrong. This is the classic example of business owners mistaking profit for cash. Profit and cash are not the same.
A business can be profitable and still go bankrupt due to a lack of cash. Sounds strange, right? This is because we are trained to believe that a business operates as follows: revenue - cost = profit. And almost always, we tend to underestimate the real cost of selling a product. Things like rent, storage, inventory, bill payments, late payments, and current liabilities are often overlooked. To pay for these costs, you need cash flow, and if your customers don't pay you on time, you have revenues but no cash. In short, profit is something that is intangible with future value, and cash is something you can spend right now.
Various factors contribute to turning your business investment into profit. Financial statements reveal all of these factors, leading you towards informed business decisions.
Who Uses Financial Statements?
Financial statements are a combination of accounting and finance. So for a small business, it will be primarily the accountant or financial controller that prepares them. They are also requested when selling or buying businesses. Also, as a small business owner, you may be required to submit these when applying for a business loan. As you can see, they are used for many things.
How to Make Sense of Them
Financial statements can be daunting to learn upfront. It can also be a time drain, taking away from more important business activities. However, considering your financial statements as a part of making important business decisions can greatly improve their outcomes. Ready to get started? There's a lot to it and many important details to understand, so we recommend going straight to the top with the SEC's authoritative guide. It's got everything you need to know in one place so you can start making informed business decisions today.
The Bottom Line
Financial statements provide you with an overview of your business health and performance. There are three main types of financial statements. By using the three financial statements in your business decisions, you can make better decisions. By making informed decisions, you save money and can be more efficient with your business initiatives. Financial statements are prepared by your accountants and should be prepared before making any important business decisions.