If you have ever tried to get any financing for your business, you probably know that one of the first things they ask for is a Financial Statement. But these statements are not only necessary for getting funding - they are a vital tool for you to look at how your company is doing now and will do into the future. As a business owner, you need to know how to read and use them.
There are three types of financial statements: the Balance Sheet, Profit & Loss Statement, and Cash Flow.
The Balance Sheet
Lenders like to look at the balance sheet to get a 'snapshot' of the financial health of your business. It makes it quick to see if your business is upside down (or if you owe more than you own). When a lender sees this, they will usually want you to flip this to put your business in a better financial position.
The balance sheet consists of two part: Assets / Liabilities and Shareholders' Equity. It is called a balance sheet because the asset section must equal the liabilities section.
Your asset section includes your cash on hand at the beginning and end of year, accounts receivables, inventories, loans to shareholders, mortgage/real estate loans, depreciable assets, land and any other assets.
Your liabilities/shareholder equity section includes your accounts payable, loans from shareholders, capital stock, retained earnings and other liabilities the company has.
You can carefully monitor this financial statement and use your progress as a way to show banks you're doing better and can be responsible for more debt.
The Profit & Loss Statement
Sometimes referred to as an 'income statement', this statement summarizes the revenues, costs, and expenses incurred during a specified period, which is usually a fiscal quarter or year. While a balance sheet shows what the company owns and owes on a given date - the income statement shows changes to accounts between specified periods of time.
Because different periods of time can be compared, it is possible to project future sales and expenses, also. If you are on an upward trajectory with your business, you might be able to secure funding based on how much profit you are expected to make down the road. This statement can make the case for that projection.
P&Ls are excellent tools to figure out if you can increase profits. For instance, if you manufacture products using cost of goods sold (such as raw materials, labor costs, and payroll taxes), you can play around with the numbers to see how changing any one of the costs can increase your profits. Making sure your costs are aligned properly will make a much more profitable company when your sales start to increase.
The Cash Flow Statement
This statement show what money you have coming in and what you are spending in a given period. It is used to determine your cash burn rate (how fast you are spending down all of your money). To determine your cash flow, you will need to document:
- Cash sales, invoices to customers that are in collections, interest on investments and loans you have given to others - (cash inflow)
- Expenses you have paid out including equipment, money owed to vendors, raw materials and debt payments - (cash outflow)
You simply subtract the cash outflows from the cash inflows to come up with your cash flow number. A positive number will help you greatly when negotiating for your business.
This statement can also help you determine if you are handling your cash properly. If the other two financial statements show the your revenue and profits are stable and you are showing a negative cash flow, something isn't right. Is there a problem with your account receivables? Do you pay your bills in too timely manner? Balancing the money coming in with the money going out is simple a matter of timing and will make sure you have the funds on hand for your business to run properly.
When to Create You Financial Statements
There is no set answer to when you should create these statements. Your articles of incorporation may require that you need to do these reports at least annually. You tax preparer may want to see them quarterly. A startup may want to review them monthly to carefully monitor their progress. And each type of report doesn't need to be done every single time either.
Today's accounting systems makes it easy to create these reports and customize them to your company's specific needs. Updating these statements often alerts you to any discrepancies or significant changes that show you where your business needs improvements. It also allows you to quickly pull correct financial information should you need to present them for lenders.