As a small business owner, it’s important to have a clear understanding of your company’s financial health. One way to achieve this is by reviewing financial statements. These reports provide valuable insight into your business’s financial standing and can help you make informed decisions about future investments and operations. Here is your Financial Statements 101 course.
In this article, we’ll provide an overview of the financial statements that small business owners should be familiar with, how to interpret them, and how to tell if your company’s financials are healthy.
Balance Sheet
The balance sheet is a financial statement that provides a snapshot of your company’s financial position at a specific point in time. It shows the assets, liabilities, and equity of your business. The formula for the balance sheet is:
Assets = Liabilities + Equity
Assets are what your business owns, such as cash, accounts receivable, inventory, and property. Liabilities are what your business owes, such as accounts payable, loans, and taxes. Equity is the difference between assets and liabilities and represents the owner’s investment in the business.
The balance sheet is an important document because it provides an overview of your company’s financial health. If your assets are greater than your liabilities, your business is considered solvent. If your liabilities are greater than your assets, your business is considered insolvent.
Income Statement
The income statement, also known as the profit and loss statement, shows your company’s revenues and expenses over a period of time. It provides information on how much money your business made and how much it spent during the period covered by the statement. The formula for the income statement is:
Revenue – Expenses = Net Income
Revenue is the money your business earned from sales or other sources. Expenses are the costs associated with running your business, such as rent, salaries, and supplies. Net income is the amount of money your business made after all expenses have been deducted.
The income statement is important because it shows whether your business is profitable or not. If your net income is positive, your business is making a profit. If your net income is negative, your business is losing money.
Cash Flow Statement
The cash flow statement shows how much cash is coming into and going out of your business over a period of time. It provides information on where your business’s cash is coming from and how it is being used. The formula for the cash flow statement is:
Cash Inflow – Cash Outflow = Net Cash Flow
Cash inflow is the money coming into your business from sources such as sales, loans, or investments. Cash outflow is the money going out of your business for expenses such as salaries, rent, and supplies. Net cash flow is the difference between cash inflow and cash outflow.
The cash flow statement is important because it shows whether your business has enough cash to pay its bills. If your net cash flow is positive, your business is generating more cash than it is using, which means it has excess cash to invest or use to pay off debt. If your net cash flow is negative, your business is using more cash than it is generating, which means it may need to borrow money or find other ways to raise cash.
Statement of Changes in Equity
The statement of changes in equity shows how your business’s equity has changed over a period of time. It provides information on how much money the owner has invested in the business, how much money has been withdrawn from the business, and how much money has been earned or lost.
The statement of changes in equity is important because it shows how much the owner has invested in the business and how much money has been earned or lost. If the owner has invested more money in the business, it means they are committed to the success of the business. If the business has earned more money than it has lost, it means the
owner’s investment in the business is paying off.
How to Interpret Financial Statements
Now that you know the basics of the financial statements, let’s talk about how to interpret them. Here are some key things to look for:
Balance Sheet
- Are your assets greater than your liabilities? If so, your business is considered solvent.
- How much of your assets are liquid (cash or easily converted to cash)? This will give you an idea of how quickly you can pay your bills if needed.
- What is your debt-to-equity ratio? This measures the amount of debt your business has compared to the amount of equity. A high debt-to-equity ratio may indicate that your business is too heavily leveraged.
Income Statement
- Is your net income positive or negative? If it’s positive, your business is making a profit. If it’s negative, your business is losing money.
- How much revenue is your business generating? Are there any trends in your revenue over time?
- Are your expenses under control? If your expenses are growing faster than your revenue, it may be a sign that you need to cut costs.
Cash Flow Statement
- Is your net cash flow positive or negative? If it’s positive, your business is generating more cash than it’s using. If it’s negative, your business is using more cash than it’s generating.
- Are there any large inflows or outflows of cash that need to be explained? For example, did you take out a loan or make a large equipment purchase?
- How much cash does your business have on hand? This will give you an idea of how much cushion you have in case of emergencies.
Statement of Changes in Equity
- How much money has the owner invested in the business? Is the owner continuing to invest in the business?
- How much money has been withdrawn from the business? Is the owner taking too much money out of the business, which could hurt its long-term financial health?
- Is the business earning a profit or experiencing a loss? Is the business’s equity growing or shrinking?
How to Tell if Your Company’s Financials are Healthy
Now that you know how to interpret financial statements, let’s talk about how to tell if your company’s financials are healthy. Here are some key indicators of financial health:
- Positive net income: Your business should be generating a profit, or at least breaking even. If your business is consistently losing money, it may be time to reassess your operations.
- Positive cash flow: Your business should be generating more cash than it’s using. If your business is consistently using more cash than it’s generating, it may be time to cut costs or find ways to generate more revenue.
- Strong balance sheet: Your business should have more assets than liabilities. Additionally, your business’s assets should be liquid, meaning they can be easily converted to cash if needed.
- Manageable debt-to-equity ratio: Your business’s debt-to-equity ratio should be manageable. A high debt-to-equity ratio may indicate that your business is too heavily leveraged.
- Growing equity: Your business’s equity should be growing over time. This means that the owner’s investment in the business is paying off and the business is becoming more valuable.
Resources for Learning More About Financial Statements and Reports
If you want to learn more about financial statements and reports, there are a number of resources available to you. Here are some of the best resources:
- The U.S. Small Business Administration (SBA) has a wealth of resources on financial statements and reports. You can find information on the SBA website, as well as at your local SBA office.
- SCORE, a nonprofit organization that provides free mentoring and education to small businesses, has a number of resources on financial statements and reports, including webinars, articles, and templates. You can access these resources on the SCORE website.
- The Financial Accounting Standards Board (FASB) sets accounting standards in the United States. The FASB website has a number of resources for small business owners, including a guide to financial statements and a guide to understanding financial statements.
- The National Association of Small Business Owners (NASBO) provides resources and support to small business owners, including information on financial statements and reports.
- The American Institute of Certified Public Accountants (AICPA) has a number of resources on financial statements and reports, including webinars, articles, and templates. You can access these resources on the AICPA website.
- Online courses and certifications are available through platforms like Coursera, Udemy, and LinkedIn Learning. These courses can provide more in-depth education on financial statements and reports.
Conclusion
Financial statements and reports are essential tools for small business owners. By understanding these statements and reports, you can gain valuable insights into your business’s financial health and make informed decisions about its future. Remember to regularly review your financial statements and reports, and don’t hesitate to seek out resources and support if you need it. With the right knowledge and tools, you can ensure the financial success of your small business.
Rising Kite Group offers coaching and consulting services to small business clients. If you are looking for more information on this topic or other business issues, we would love to give you a free 20 minute consultation to see if we can help you. Our team assembles these articles using personal experience and online tools including AI resources. If you have thoughts or comments on this article please contact us and let us know.