Types of Financial Statements Every Founder Should Know About
As a small business owner or founder, you may think that only you and your accountant are interested in your company’s financial statements. But contrary to this assumption, investors and financial lenders will be interested in four types of financial statements from your business.
What Are Financial Statements and Why Do I Need Them?
Business financial statements act as a dashboard that tells you where your money is coming from and where it is going. They are a collection of reports summarizing essential financial information, including financial results, position, and cash flow. There are four main types of financial statements, and they include:
- Balance sheet
- Income statement
- Cash flow statement
- Statement of shareholder’s equity
These statements are essential in investment analysis. Each of these statements contains numbers that reflect your company’s products, services, business, and macro-fundamental events. In addition, the statements are essential in:
- Determining your business’s ability to generate cash, the source of that cash, and how you spend it
- Determining whether your business can pay back its debts
- Tracking your company’s financial results on a trend line to spot any impending profitability issues
- Deriving financial ratios to determine the condition of the business
- Using them as a basis for creating the company’s annual reports to distribute to its investors and the investment community
By preparing your business financial statements, you get a clear picture of your business’s resources and how you financed them as of a particular date.
A balance sheet is an accounting statement that summarizes your company’s financial health over a specified period. It’s a one-page document containing three essential elements:
- Assets – items of value to your business arranged in the order of their liquidity. These may include cash, inventory, accounts receivable, prepaid expenses, furniture and fixtures, vehicles, equipment, machinery, land, and buildings.
- Liabilities – what money your company currently owes others. They include accounts payable, accrued employee salaries and wages, interest payable, and customer deposits.
- Stockholders equity – the value of funds shareholders have invested in your business and any retained earnings. Stockholders’ equity accounts include retained earnings, preferred stock, and common stock.
Think of the balance sheet as a snapshot of your business financial position as of a certain point in time.
Purpose of a Balance Sheet
Understanding how to prepare your company’s balance sheet gives a better insight into your company’s financial situation. There’s no specific time when you should generate the balance sheet, although most track as of the end of each month. Comparing the balance sheet as of different periods allows you to compare the health of the company over time.
The income statement outlines your company’s income and expenses over the reporting period. It focuses on revenue and costs, hence effective in helping you determine which activities brought money to your business and which spent cash. The income statement includes the following information:
- Revenue – the amount of money the company made during the reporting period.
- Expenses – the amount of money the business spent during the reporting period.
- Gross profit – total revenue minus the cost of goods sold.
- Cost of Goods Sold (COGS) – the cost directly associated with producing or providing the products or services your business offers.
- Operating income – gross profit minus the operating expenses.
- EBITDA – the earnings before interest, depreciation, taxes, and amortization.
- Net income – your company’s net earnings after deducting allowable business expenses.
Purpose of an Income Statement
Income statements are essential in:
- Tracking the business financial performance over a period of time. Highlighting income and expenses that can be compared to the expected budget to see where there were wins and misses.
- Since you produce income statements monthly, you can use them to monitor your business’s performance to make informed decisions closely. In addition, you can identify any minor problems earlier and fix them before they become unmanageable.
- Providing investors with a clear overview of the business they want to invest in. Banks and other financial institutions can also use income statements to decide whether your business is loan-worthy.
Cash Flow Statement
A cash flow statement is a financial report indicating the cash generated and spent over a specific time. It is a valuable tool for managing your company’s cash flow by monitoring incoming and outgoing money. The cash flow statement has three main parts:
- Cash flow from operating activities – business activities that record money spent on producing products and services or generate revenue for the business. They include inventory transactions, employee’s wages, interest payments, tax payments, and rent payments.
- Cash flow from investing activities – this section records the company’s gains and losses resulting from investment in assets such as property, plant, equipment (PPE), which change the company’s cash flow position. Changes in the company’s cash flow are essential in determining your business’s investment in PPE.
- Cash flow from financing activities – this section shows the cash flow between the business, its owners, and creditors. These activities include equity, debts, and dividends.
Purpose of a Cash Flow Statement
The cash flow statement is helpful in:
- Providing details on your spending by highlighting principal payments to creditors and other transactions not shown clearly in other financial statements.
- Maintaining an optimum cash balance to help you determine if too much of your cash is lying idle or there’s a cash shortage. If you have idle cash, you can buy inventory or other assets to provide future benefit. On the other hand, you can handle cash shortages by looking for sources to borrow funds to keep the business on its feet.
- Helping you focus on cash generation methods other than profit. For instance, you can find ways to pay less for equipment or receive collectibles from customers.
- Controlling cash flow for short-term planning. You can use this financial statement to analyze incoming and outgoing cash from past transactions to make informed decisions.
Statement of Shareholders’ Equity
The statement of shareholders’ equity indicates the changes in value to shareholders’ equity or ownership interest in a company over a given accounting period.
You can determine the shareholders’ equity by calculating the difference between your business’s assets and liabilities. The statement contains the following components:
- Preferred stock – a type of ownership stake in a company that provides stakeholders with a higher claim on a business’s earnings and assets than those who own common stock.
- Common stock – a type of ownership stake in a company that gives stakeholders voting rights on corporate decisions.
- Treasury stock – a form of stock that the issuing company repurchases. You can decide to repurchase your stock to boost the company’s stock price or prevent a hostile takeover.
- Retained earnings – the accumulation of total net income that the business has brought in but not yet distributed to shareholders.
Purpose of Shareholders’ Equity
The shareholders’ equity statement is essential in:
- Making important accounting decisions such as whether you should borrow more money for expansion or cut costs.
- Gauging how well you are running the business. For example, if your shareholders’ equity declines from one accounting period to the other, that’s a sign that you’re doing something wrong.
- Helping your business through financial difficulties by revealing whether you have enough equity to get your business through a downturn.
Are CFOs Responsible for Preparing Business Financials?
Financial statements are an integral part of your business. They help you fulfill compliance obligations set by the legislator and allow you to manage your business and outline further development.
While your company’s CFO is responsible for the fiscal health of your business by making important accounting decisions, they may not have enough time to prepare financial statements. In this case, they can opt to get your company’s financial statements prepared by an outsourced company.
Outsourced accounting gives you an accurate picture of your finances since the outsourcing company, such as hiline, will have ample knowledge of accounting rules. In addition, these accounting services help automate your accounting system leveraging technology, ensuring that every transaction is accurately recorded. As a result, you get quality financial statements prepared and reviewed by experts.
When your financial statements are accurate, it becomes easy for investors, banks, and lenders to decide whether your business is worth investing in or lending a loan or not.
Financial Statements Shouldn’t Take Up Time During Your Day
Preparing different types of financial statements can be time-consuming. However, this doesn’t lessen the need to prepare monthly, quarterly, or yearly reports to make informed accounting decisions. That’s why at hiline, we offer financial statement preparation services that are well-suited for small and medium-sized businesses.
We strongly believe in providing top-notch accounting services to our clients across multiple industries. Therefore, if you decide to outsource your bookkeeping services, call us today and experience the hiline advantage!
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