Financial statement reports provide an overview of the financial activities of  businesses. These statements can be crucial to helping a small business owner quickly identify areas of concern. It can also prove helpful in determining whether a business has the finances in place to grow and expand.

When seeking financing or partnerships, businesses will provide financial statements to give solid evidence of the company’s value.

Financial Statement Preparation

Three financial statements make up a business’s financial report card: balance sheet, income statement and cash flow statement.  A balance sheet lists what your company owns (assets), what it owes to others (liabilities), and what it owes to the owners (equity). Use the balance sheet to track changes in your business, to show financial strength for securing loans and as a basis for forecasting. The income statement (also known as a profit and loss statement) summarizes income, expenses and profits for a period of time.  It is a record of your company’s operations and its ability to generate profits, which are essential for long-term survival.  A cash flow statement shows how long it takes between the time you spend cash until you get cash back. It is important to keep this time to a minimum to make sure you have enough cash on hand to pay everyone, including yourself!

Ignoring your financial statement is like ignoring the health of your business. Startups and new business owners often overlook understanding gross margin. This can have a direct impact on your ability to effectively manage a growing business, price your products, and most importantly, make a profit.

Accurately tracking financial data is not only critical for running the day-to-day operations of your small business, but it is also essential when seeking funding from lenders or investors to take your business to the next level. In addition, keeping tabs of your finances can help ensure your products and services are priced right, identify what your margins are, determine your cash flow and make filing taxes easier.

Here are the three critical financial statement reports your business needs:

1) PROFIT & LOSS STATEMENT

Your Profit & Loss (P&L) or income statement shows your revenue, costs, and expenses during any given period of time. The P&L is the best view into your bottom line, or net income, which is why it’s typically used to show business lenders and investors whether your company has made or lost money during a given period. In addition to showing how profitable your business is, your P&L statement also sheds insight on what money is left in the business to pay your salary, clear debts, fund growth or hire an employee. It’s your financial health report card.

The P&L statement should be reviewed  at  a minimum on a monthly basis. SL will keep an eye on key financial statements and indicators that impact your business such as:

  • Increasing sales, but declining profit
  • Stationary sales.
  • Increases in overhead (utilities, rent, insurance, etc.).
  • Increases in the cost of goods/services sold (COGS).

 

2) BALANCE SHEET 

The balance sheet is one of the most important financial statements because it shows a “snapshot” of a company’s financial standing. Also known as the statement of financial position, it enables you to see what a business owns and what it owes. Concisely, the balance sheet breaks down a company’s assets, liabilities, and owner’s equity at a specific point in time. This helps you as a business owner determine the financial strength and ability of your business.

A balance sheet is one of the fundamental financial statements used by most businesses. It details the company’s financial standing at a particular moment. The balance sheet reports the assets — property and rights to property — belonging to the company, such as equipment and accounts receivable. The balance sheet also shows the liabilities — debts or obligations — owed to others, such as accounts payable and notes payable. Lastly, the balance sheet reports the equity belonging to the company. Equity is the amount remaining after deducting liabilities from assets; this is the amount to which the owner has claim. The balance sheet is governed by the fundamental accounting equation: Assets are always equal to liabilities and equity together.

The balance sheet is quickly overlooked by business owners as they focus on daily operations and the challenges of running the company. However, setting this data aside is a grave error that can cripple small businesses. Successful companies keep their financial statements front and center, creating their short and long-term strategic plans with an eye on current and future balance sheet figures.

The balance sheet view differs from the information offered on income statements significantly, in that an income statement appears as a snapshot in time. It shows revenue that has been earned and expenses that have been paid, but there is no visibility into what is owed. Over-reliance on the income statement can lead to disastrous spending strategies, ultimately crippling cash flow.

Review and analysis of balance sheet data allows users to ascertain the financial health of the business. For example:

  • Cash balance indicates how well a business is converting its net revenue into cash
  • Accounts receivable cycle time if lengthened may indicate difficulties collecting from credit sales
  • Excess inventory relative to other assets can create additional expenses for storing, maintaining and insuring inventory, and risk of obsolescence
  • Inventory shortage may lead to  long delays in fulfilling customer requests and result in lost revenues
  • Accounts payable turnover ratio indicates how quickly the company pays off its vendors
  • Determines if cash reserves are inadequate which can lead to cash flow issues.
  • How fast or slow assets can be converted to capital.
  • Determines the productivity and solvency of the business.
  • The amount of capital retained in the business.

 

Financial Analysis

Financial ratios computed from the balance sheet can determine if your business is in a position to expand.

Investors and lenders review the balance sheet to compute financial rations to make funding decisions. Vendors who are considering how much credit to grant you will also review your balance sheet.

Some key ratios are:

  • Current Ratio = Current Assets ÷ Current Liabilities: The current ratio shows whether the business has enough cash on hand to pay bills coming due in the near future.
  • Quick Ratio= (Current Assets – Inventory) ÷ Current Liabilities: Liquidity ratios measure a company’s liquid assets against its short-term liabilities. Generally the more liquid assets you have to cover short-term liabilities, the more likely it is that you’ll be able to pay debts as they become due without running out of funds to support ongoing operations.
  • Debt-to-Equity Ratio = Total Liabilities ÷ Shareholders’ Equity: The debt-to-equity ratio compares how much the business investors own versus how much is owed to creditors outside the business. This ratio illustrates the extent to which the business relies on debt to operate.
  • Working Capital = Current Assets – Current Liabilities: A positive working capital figure is desirable in some industries, however others prefer to see negative working capital on this line. Regardless of which applies to your small business, the balance sheet permits you to monitor the situation, making corrections as applicable.   

 

3) CASHFLOW STATEMENT 

Small businesses run on cash and knowing where cash is and where it’s gone is among the most important things a small business owner can know. The cash flow statement enables the owner, managers, bankers and suppliers to view the company’s operations from a cash perspective so they better understand how smoothly the operations are running, where growth funding is coming from and how wisely the money is spent.

Cash flow statements confirms  whether  your business is consistently generating more cash than it spends, your ability to pay off debt, increase your dividend, or even acquire another business is enhanced. A cash flow statement is particularly important to investors seeking to determine the short-term viability of your company, particularly its ability to generate cash and pay bills.

The three common classifications on Cash Flow Statements include cash provided or used in:

Operating Activities – Revenue-generating activities of the business entity, they include cash effects of transactions by which net profit or loss is determined.

Investing Activities – Typically activities involving the acquisition and sale of fixed assets (building and equipment) but can also include stocks and other investments if not held for resale as a primary business activity.

Financing Activities – Activities which change the size and the composition of owners’ capital or changes in debt. (i.e. contributions, distributions, stock issuance and purchase, and debt).

 

The Importance of the Cash Flow Statement

Cash can come from both internal and external sources, and the Statement of Cash Flow helps companies and investors separate and observe the differences and extent of the cash inflows and outflows. Internal cash sources provide a company with successful attributes and assurances that include:

1) preventing and monitoring company debt

2) preventing unnecessary expenditures from interest, late payment penalties and debt costs

3) ensuring timely investment and cash available for investment opportunities

4) ensuring timely payment of expenses and debts

5) and most importantly — ensuring a level of regular business income without relying on outside investment or cash borrowing.

An income statement does not reveal hidden problems, like insufficient cash flow. Earnings only provide information about money coming into the business, cash flow is a statement addressing how a business receives money (from its sales and investments) as well as the ways in which it spends money (on operating expenses, capital investments, taxes and interest). In other words, cash flow is more than just measuring over-the-counter revenue.

REVIEW CASH FLOW STATEMENT

Periodic review of the cash flow statement for rapidly growing companies can identify the need for cash and use financing to cover the shortfalls. A troubled company could head off financial distress by noticing negative operating cash, minimal investing cash and significant financing cash flow. The owner who sees this could restructure operations and revamp the financing structure.

If your company isn’t doing a good job of managing the amount of cash entering and exiting, you may be setting yourself up for failure.  You don’t have to struggle with your financials we can help. Contact us today to schedule a strategy session: http://bit.ly/2VsmqiQ