If you’re a business owner, you probably understand the importance of a financial statement. It provides anyone who needs to know with a clear understanding of your businesses assets, liabilities, income and working capital. It shows where your money came from, where it went, and where it is now.
Financial statements are useful for two main reasons: It gives the business a clear picture of its financial health to help plan for the future, and it gives lenders a clear picture of the business’s financial health to help them make a credit decision. Because of that significance, you’ll want to make sure you’re creating one accurately.
The easiest (and perhaps most tried and true) way to create a financial statement is to have a Certified Public Accountant create it for you. Otherwise, you can start creating your own by breaking it down into three sections: balance sheet, income statement and cash flow statement.
The first part is your balance sheet, which shows your business as it stands. It gives a snapshot of the company’s current assets, liabilities and shareholders’ equity. The basic formula for a balance sheet is “Assets = Liabilities + Shareholders’ Equity”. Of course, it’s important to understand what each of those means, specifically.
Assets are things owned by the company that are of value and can be measured and expressed in dollars. They also include costs paid in advance that have not expired yet (such as prepaid advertising, prepaid insurance, prepaid legal fees and prepaid rent).1
Examples of assets that are reported on a company’s balance sheet include: cash, petty cash, temporary investments, accounts receivable, inventory, supplies, prepaid insurance, land, land improvements, buildings, equipment, goodwill.
Once you have your assets identified, they should be sorted into two categories: current assets, for things the company expects to convert to cash within one year, and non-current assets, which are things the company doesn’t expect to convert to cash within a year.
Liabilities are things the company owes to others (such as creditors). They also include amounts received in advance for future services.1
Examples of liabilities include: notes payable, accounts payable, salaries payable, wages payable, interest payable, taxes payable, customer deposits, warranty liability, lawsuits payable, unearned revenues, bonds payable.
Just as we split up the assets, we similarly split up the liabilities into current liabilities, which are debts a company expects to pay off within the year, and long-term liabilities, which are obligations that are due in more than a year.
Then comes the shareholders’ equity, which is the money that would be left if a company sold all its assets and paid off all liabilities. This amount would exclude the money used to start the business, as well as profits kept in the company from previous years.
Next comes your income statement. The income statement is a report that shows how much revenue a company earned over a specific period of time. It’s the best way to determine the profitability of a company. The basic formula for an income statement is “Net income = (Revenues + Gains) – (Expenses + Losses).”
Your revenues and gains report all the income during a specific period of time. Conversely, your expenses and losses report all the outgoings during a specific period of time. After listing all of each, the bottom line shows the company’s net income.
While an income statement can show you whether your company made a profit, a cash flow statement can tell you whether the company actually generated or lost cash. It does this by reporting a company’s inflows and outflows of cash during a specific period of time.
Cash flow is broken down into operating activities; which are regular and core activities that generate cash inflows and outflows; investing activities, which are changes in cash from the purchase or sale of property or other long-term investments; and financing activities, which are cash level changes from the purchase of a company’s own stock or issue of bonds, as well as payments of interest and dividends to shareholders.2
These three sections all combine to make up your business financial statement. You should keep one current at all times to know where your business is heading, and to support your likelihood of receiving business financing in the future.