There are 3 Main Financial Statements:
- Balance Sheet Shows what a company owns and what it owes at a fixed point in time
- Profit and Loss Shows how much money a company made and spent over a period of time
- Statement of Cash Flows Shows the exchange of money between a company and the outside world over a period of time
To run and read reports effectively, you need an understanding of the fundamentals of reporting. The first thing to know is cash vs. accrual. Cash-basis reports display income at the time it was received and expenses at the time they were paid, regardless of the dates on invoices or bills. Accrual-basis reports display income at the time it was invoiced and expenses at the time they were incurred, based on the dates on invoices and bills. It is important to understand the differences between these reporting methods and the effect changing the basis can have on your reports. It is good to view accrual-based reports to see income earned and expenses incurred, but it can also be beneficial to view cash-based reports to gain perspective on cash flow.
What is my business worth?
A Balance Sheet provides a financial snapshot of your company. It lists the balances for each asset, liability and equity account as of a specific date. It also calculates what your business is worth (the equity) by subtracting what your company owes (liabilities) from everything it owns (assets).
- Assets are things a company owns that have value. This typically means they can be sold or used by the company to make products or provide services that can be sold. Assets include physical property
such as plants, trucks, equipment and inventory. It also includes things that can’t be touched physically but have value, such as trademarks and patents. And cash itself is an asset, as are the
investments a company makes.
- Liabilities are amounts of money a company owes to others. This can include all kinds of obligations like money borrowed from a bank to launch a new product, rent owed to the landlord for use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future.
- Equity is the summary of the net worth of the business (assets minus liabilities) as well as the company’s interaction with the owners. Are the owners putting money into the business or taking it out, or did a new owner invest into the company? These transactions would be summarized in the Equity section.
Profit and Loss
How much did I Make and Spend?
A Profit and Loss report is also called an Income Statement or a P&L. It gives a synopsis of the story. It summarizes your income and expenses for each income, cost of goods sold and expense account on your Chart of Accounts so you can tell if you’re operating at a profit or loss. The important thing to remember about an income statement is it represents results over a period of time. This contrasts with the balance sheet, which represents a snapshot at a single moment in time.
To understand how Profit and Loss reports are set up, think of them as a set of stairs. You start at the top with the total amount of sales and income made during the accounting period. Then you go down one step at a time. At each step you make a deduction for certain costs or other operating expenses. At the bottom of the stairs, after deducting all the expenses, you learn how much the company earned or lost during the accounting period. This is called the bottom line.
Imagine a business owner who has designed a new product. They need to set a few milestones and here are the goals:
- Goal #1: Make sales – The product they designed should be something that will be of value to someone else so they can receive income. That is the first section of the Profit and Loss — the Income/Revenues.
- Goal #2: Sell the product at a price that will pay for the cost to produce it – If it costs $5 to create the product each time, then hopefully they sell it for more than that. This is the next section of the Profit and Loss — the Cost of Goods Sold. This brings us to a gross profit amount, which is derived by subtracting the cost of goods sold from the total income.
- Goal #3: Sell enough of the product to cover the costs of running a business (overhead) – It costs money to have a business. The expenses they have to pay for, regardless of selling one or 1,000 units of the products or services, are considered overhead. Overhead could be professional fees, payroll, office rent, bank service charges and more. Net Operating Income shows whether this goal has been accomplished.
Goal #4: Earn a profit so you can take some money home – Other things can happen like a theft or interest income that are not part of the company’s operations. The overall net income of the business shows whether this business owner has made any money. Then the owner decides whether to take some home or reinvest it in the company’s future.
Statement of Cash Flows
Where did my money go?
In most small businesses, revenue doesn’t always match up with spending, so understanding your cash flow is critical. The cash flow statement—also known as a statement of cash flows—helps you evaluate whether there is enough money coming in, and enough cash on hand, to pay your bills. In financial accounting, a cash flow statement provides a snapshot of your cash balance.
The cash flow statement helps you look back over a specific period (typically a quarter) to predict the net cash, or amount of cash, you will need over a specific accounting period to fund your operating activities.
Cash flow should not be confused with profit. Profit refers to the difference between revenue and cost over a period of time, whereas cash flow measures your cash on hand. A small business may be profitable but still not have the cash needed to pay employees, vendors, or creditors. Businesses need to manage cash flow to ensure that there is enough money coming in to pay the bills today.
The cash flow statement is one of the three key financial statements used to assess a company’s financial status. The other two are the balance sheet and the income statement. All three financial reports work together to provide insight into the financial position of the business. For example, the ending cash balance in the statement of cash flows should equal the ending cash balance in the balance sheet.
A cash flow statement is used to attract new investments, inform your fundraising efforts, and get more access to financing options. For banks and creditors, your cash flow statement provides some reassurance that your small business is able to pay back its loans or fund its own operating expenses.
🔽Download David’s Guide to defining your Profit and Loss, Balance Sheet and Cashflow here.
Since 2018, Friest Management has been providing trusted bookkeeping services that meet a wide range of corporate and personal needs to our clients in the Des Moines area. In 2021, leveraging current and emerging technologies, we began to offer services nationwide and remotely. We are here to handle all of your financial management demands so you can focus on your core priorities — in business and life.