Many people get very intimidated when it comes to financial statements, but the reality is that if you can read a nutrition label on a food box, you can learn how to read and understand a financial statement.
What Are Financial Statements?
In the world of business, there are two main streams of money movement. The first is income or the money that comes into the business from investors or from the selling of their products or services. The second is expenses or the money that is going out of the business to pay for equipment, office space, and the salaries of their employees.
Financial statements help to make sense of the money moving in and out so that a business can know if they have healthy cash flow as well as for taxes and duties. The main financial statements that businesses look at are balance sheets, income statements, and cash flow statements. Let’s go into each one of these in more detail.
A balance sheet is a financial statement that gives information on a company’s liabilities, assets, and potential shareholder equity.
Assets are things that a company owns that have monetary value, such as real estate, inventory, or equipment. These assets could be sold for money in order to be used as collateral. If the company also has a war chest of cash, this cash can be considered an asset on the balance sheet.
Liabilities are amounts of money that the company owes to someone else. This can include things like loan payments, rent for the office space, and payroll to workers. Liabilities can also include promised goods or services that are to be delivered or performed to a customer by a certain date.
Most balance sheets use the following equation:
Assets = Liabilities + Shareholder’s Equity
A balance sheet will typically list the assets of the company on the left-hand side, and the liabilities on the right-hand side of the report. This balance sheet provides a snapshot of a company to help them see where they currently stand with assets and liabilities.
A business needs to know how much money they brought in within a certain time frame. Income statements are designed to show just that. The income statement also will show the costs or expenses that were required to bring in that money to show you if you actually made a profit, or went into a deficit.
One way to think about an income statement is to imagine a set of stairs. When you start at the top of the stairs, you are viewing the total amount of sales made during the specified time period. As you go down each step, you are making deductions for certain costs or expenses that you incurred for operation. As you make it to the bottom of the stairs, you will see if there was any money left over, or if you went into a negative position. Understanding each step can give you the power to know what steps can be eliminated altogether in order to improve your bottom line, or which steps can be reduced in cost.
Understanding these different steps that deduct income is very important and requires analysis to pinpoint places where the company may be bleeding money. This is the job of most accounting departments to make sure that there wasn’t an accounting error to determine which process or step in the process may need additional refining or elimination.
Cash Flow Statements
This is where most businesses live or die. If you are spending money faster than you are bringing it in, then you have a recipe for disaster. A cash flow statement shows the net increase and decrease in cash in a specified period of time. The biggest difference between this statement and an income statement is that this statement will actually tell you if the business generated cash.
This report shows changes over time rather than absolute dollar amounts since the purpose of this report is to show cash generation. Most cash flow statements include operating activities, investing activities, and financing activities.
As you can see, having accurate financial statements can be imperative to help any business determine how much money they have made, how much they have spent, and if they are generating it fast enough to stay afloat. Accounting departments live and breathe by these financial statements to ensure that the business has a steady influx of cash being generated, as well as pinpoint areas that may need some refining or elimination in order to keep the company in a healthy financial state.
Most business executives look at these three reports at least once a week. Understanding where your money is coming from and how it is being spent is a core factor in keeping a company healthy and viable for the future.