A financial statement doesn't have to overwhelm you. Understanding your company's financial statement and subsequently taking the time to learn how to read through it, will have a positive impact on your business. Basically, a financial statement will outline the liabilities, assets, and losses associated with your company. Below is a quick guide to gaining a better understanding of this ever so crucial document.
Reading a Financial Statement
You can think of the financial statement as a three-part informational outline of your company; in other words, it sums up where you began, what your firm did from there and ultimately where it looks to be going. The main parts of the financial statement are the balance sheet, an income statement as well as a cash flow statement.
What Exactly is a Balance Sheet?
The balance sheet is the overall picture of your finances. Generally, it is done monthly, quarterly and yearly. Most often the balance sheet will feature the business assets and liabilities as well as where shareholder equity stands at that time. The ratio between assets and liabilities is key here. This lets you know if there are enough positive cash flow and money within the company to take care of outstanding debts. If the ratio falls too low, you could be approaching some major challenges as far as your company finances go.
Assets
Assets are more than just the physicaltangible items that the company holds, it is also the cash that you happen to have on hand. As far as those things owned by the business, to figure out what they're worth, you'd assess fair market value at the time of calculation.
Your current assets are those items that are meant to be sold within a twelve-month time frame and thus converted to their cash equivalent. So for example, if you're a car dealership, your inventory would be considered assets.
There are also what are called non-current assets; these are items that you probably are not going to sell but that have value in terms of your company—so for instance, your technology and hardware.
Liabilities
Liabilities are essentially all of your company debt—so what you owe to suppliers, lenders, etc.
Current Liabilities are generally considered to be those items that you owe within the calendar year. Let's say for example you have hired a subcontractor to do work for you; that invoice owed would be a current liability.
Whereas, long-term liabilities are those debts that do not necessarily have to be paid off within a twelve month period. So for example, the mortgage on the office where you conduct business is a long-term liability.
Shareholder Equity
This represents that which would remain should you have to liquidate, sell off assets and pay off any and all existing debt.
Understanding The Income Statement
In order to have a clearer picture of your company's profitability within a given period, you need to generate what is called an income statement. This basically lists out all of your earned revenue along with your expenses in order to determine net loss or gain. In essence, it answers that age-old question: is my company actually making money?
Revenue
Your revenue includes all of the money you made over a certain period of time. It could be from sales, money from services rendered, also income from any investments the company may have.
Expenses
Expenses, as is probably clear, represents all of the money going out of the business at that time. So everything from employee salaries, to inventory costs, to marketing expenses even. Also, if you took a hit on any investments, you need to note this as well.
What is a Cash Flow Statement?
Whereas the income statement shows a profit, the cash flow statement will show you whether or not you made or lost cash during a specific period of time. This statement is most often comprised of three parts: operating activities which includes how you generate cash, be it through product sales and it also notes salaries and inventory purchases as an outflow of cash. Investing activities show changes in cash position as a result of purchasing/selling property, equipment or other such tangible assets. Finally, financing activities relate to cash flow changes arising from stock/bond transactions as well as shareholder payments.
Budget Comparisons
Every business has a budget. This is what you project for the year as far as income, spending and potential debt. The budget is extremely important as it helps you to keep track of where the company is going financially speaking. Are you headed in the direction you thought? Do you need to make adjustments?
In creating your budget, you want to break everything down into line items. This gives you a clearer understanding of the
terms of whether or not you are hitting your goals, and whether or not your spending is exceeding budgeting.
When you start to track performance against budget projections you are better able to understand your company's pacing, and the pacing is critical. If you are lagging behind where you thought you should be given the budget, then it is time to start playing catchup. Again, making quarterly or even monthly adjustments in order to keep moving forward productively is essential to the longevity of your organization.
Measuring Your Business Success
The various components of your financial statement are interconnected. One will inevitably affect the other. On their own, each can provide a detailed picture of that aspect of your company, but when taken together you get a very comprehensive portrait of where you are and what you need to do moving forward. Furthermore, if you take this insight regarding your cash flow, liabilities and profitability and measure it against your budget, you get yet another dimension to examine. The more you know about your company's performance and the better you understand your financials as a whole, the more prepared you will be to make those changes that need to be made and thus set your company up for success.
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