3 most important financial statements for your Business
Trying to run a business without keeping a check on the Cash flow, Balance sheet and Profit and loss statement is like driving a car without the engine. It is critical to understand this concept to plan the future and manage your operations and taxes. It is also important to keep your financial health in check as your investors might ask for these statements at the time of fundraising and you don’t want to have enough cash in your business. Financial statements are the best source to evaluate the weaknesses and strengths of your company’s financial health.
Let’s understand each of these important financial statements in detail:-
1. Cash flow
7 out of 10 start-ups fail because of poor cash flow management. Running out of money is the most critical situation where most of the start-ups fail. You always need to know where the money is coming from and where the money is going. A Cashflow financial statement helps your business to identify the risks while moving forward. It also records all the relevant activities for the current period. Cash Flow management is the amount of cash collected and used by a company during a period and is one of the most important aspects to understand running a business. You are going to put your business in a very dangerous position if you don’t stay on top of your cash flow.
Let’s break down cash flow into 3 important financial statement categories:-
- Operating cash flow – The money which is coming from normal business activities.
- Investing cash flow – The money which is coming from investing activities like- Property, Plants, stocks, equipment, etc.
- Financing cash flow – It includes transactions involving e
- quity, debt and dividends.
2. Balance sheet
The balance sheet reflects the financial statement of your company. It is a combination of your company’s assets and liability. If both assets and liability match then only your account is balanced. Let’s understand the balance sheet–
A balance sheet helps in determining the financial stability of your business. Investors and creditors always analyze the balance sheet of your company before investing. A balance sheet also indicates the unexpected expenses and your liquidity position.
Asset + Liability = Equity (It shows the basic accounting equations)
- Assets – Asset includes inventory, investment, equipment and machinery, cash, account receivables and checking account. Assets are the resources that are owned by the business owner and can be measured.
- Liability – Liability includes things that you owe to others like- loans, share capital, surplus, payroll, etc.
- Equity – Equity includes the capital investments that you have made in the business.
Look for these items when reviewing the balance sheet:-
- Negative Balance
- Balance which seems too low or too high
- Balance in the account that must be zero
- Balance in account payable (AP) and account receivable (AR).
3. Profit and loss statement
Profit can be made when your revenue exceeds costs or expenses but if the cost exceeds revenue then a loss is projected.
The profit and loss statement records the performance of your business and shows the result if the company is financially healthy or not.
The profit and loss statement shows where the money is being allocated and also breaks down the business cost into categories for your financial statement.
Let’s look at the components of profit and loss:-
- Income – It refers to the revenue earned by your company by the core operation and secondary sources such as interest income.
- Cost of goods sold – It includes the costs related to the product sale in your inventory. The cost of goods sold is also known by the cost of sales.
- Gross profit margin – Gross profit margin is the difference between the revenue and the cost of sales. It indicates the ability to cover the remaining expenses apart from the cost of sales.
- Operating expenses – It includes selling, administrative, salaries, and general expenses.
- Operating income – It comes by subtracting the operating expenses from the gross margin.
- Depreciation – It reflects the reduction in the value of an asset like equipment that is being used to generate income.
- Interest – Interest refers to the cost of borrowing funds to finance the business’s assets.
- Net Income – It reflects the company’s bottom line. If the company’s expenses exceed then it will be recorded as a net loss.
These Important Financial statements are critical to evaluate the performance of your business yearly. As a business owner, one must know the basics of these important financial statements to understand the monetary health of your company. It will also help you to take the necessary decisions on time.