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Sabrina G. Anwah is an entrepreneur and founder of D.C.-based creatives services and communications firm, Words Into Hype. She works with clients to improving their business visibility and increase their revenue by evaluating their goals, identify their strengths, target the appropriate audiences, and produce attention-getting, intriguing and accurate content. Sabrina covers small business, entrepreneurship, and business finance topics for The Balance.
Updated on September 19, 2022 In This Article In This Article
Financial statements provide a look into the financial life of a company. They show how money flows through the company, and reveals its financial health. For small business owners seeking investment opportunities or seeking to attract investors, it is beneficial to know how to create and evaluate these reports.
When it comes to establishing financial statements, decide on the reporting period or how often the statements will be created: monthly, quarterly, or annually. You can use accounting software, which can make creating these reports much easier, or seek professional accounting help if you need it.
In this article, you will learn about three types of financial statements: balance sheets, income statements (also called profit and loss or P&L statements), and cash flow statements.
“By definition, the balance sheet speaks to the company’s health. However, not being a good steward over the P&L and cash flow statements would be the equivalent of a diabetic never monitoring their glucose levels. It can lead to irreversible tragedy,” said George Dandridge Jr., EA, NTPIF, CTC, President of Elite 8 Tax and Financial Services. Dandrige works extensively with small businesses to establish sound accounting practices.
“My experience has been that most business owners wait too late to address the P&L and do not have a cash flow statement. The cash flow statement is a great indicator of if a company is profitable in most cases,” he told The Balance.
A balance sheet provides the financial snapshot of your business. It is the first thing investors and banks want to see if you’re looking to raise additional capital, and typically what they rely on heavily to give you money.
“If a company’s balance sheet has too much debt or too few assets, it will be difficult to secure a bank loan or surety bonding,” said Dandridge.
Assets are valuable properties, cash, investments, patents, or trademarks owned by a company. Assets can be current (can be liquidated within a year) or noncurrent (will take longer than a year to sell). Some noncurrent assets are fixed, or not sellable, because they are needed to operate the business, such as vehicles or office furniture.
Liabilities are debts the company owes for supplies, business loans, rent on a property, payroll, and other obligations. Liabilities can also be current or long term.
Shareholders’ equity, also called capital or net worth, is the cash value of the company if all assets were to be sold and all liabilities paid off. Shareholders’ equity is the amount owners invested in the company’s stock plus or minus the company’s earnings or losses since its inception.
Balance statements only show the state of the company at the end of the reporting period, not the activities along the way.
To investigate the financial health of a company, investors often use “ratios” to analyze two or more components of a financial statement. For balance sheet reports, these include:
Income statements report how much revenue a company profited or lost over the reporting period. The report also includes earnings per share (EPS), which details how much money the company’s shareholders could expect to receive if the company made a distribution of all its net earnings for the period.
The report starts with the “gross revenue,” or the total amount of revenue earned through the sale of products or services. “Gross” indicates that this total is not final, as it does not reflect the whole story because expenses have not been addressed.
After stating the revenue earned, the statement will list and deduct the amount of money the company cannot collect from the sales it made (due to such things as returns or discounts). The “net” revenues, or the amount of money remaining after the deductions, will be stated.
Several expenses then are taken from the net revenue. These deductions vary, but usually start with the cost of making sales. The total after deducting these expenses is called the “gross profit” or “gross margin.” Once again, “gross” indicates that the figure is not final as more deductions for expenses are to come. Operating expenses such as marketing costs, staff salaries, and product research are then deducted from the total.
Companies are allowed to expense the depreciation (amortization) of certain assets (machines, furniture, etc.) over the time they are used.
Following these deductions, the income statement will list “income from operations” or the operating profit before income tax or interest expenses are taken. Both “interest expenses” (the interest a company paid for loans) or “interest income” (money the company earned through investments) are then either subtracted from or added to the operating profit. Finally, income taxes are deducted to determine the net profit (also called net income or net earnings) or net losses. At this point, it is clear if the company earned a profit or sustained losses over the accounting period.
“The income statement is one of the most valuable tools in making short-term decisions while also revealing the results of past decisions,” said Dandridge. “Understanding specific revenues and the expenses and generating them will illustrate what products or services your company may need to remove or double down on.”
Some income statement ratios are:
A cash flow statement reports the company’s inflow and outflow of cash. It shows the net increases or decreases in cash for the reporting period from operating activities, investing activities, and financing activities.
“Business owners tend to always miss accounting for cash spent, and some tend to not record cash received,” said Dandridge. “This puts everything out of balance. For small businesses, co-mingling is an Achilles heel, especially if they are ever audited.”
Depending on the complexity of the business’s cash flow, while it may not be worth the owner’s time to execute financial reports, it is crucial. Business owners would be better off hiring professionals to help them.
There are three types of cash detailed in these reports:
Most U.S. public companies are required to file their financial information with the U.S. Securities and Exchange Commission (SEC). The companies are required to file Form 10-K for annual information, and Form 10-Q is required after the company's first through third fiscal quarter. While the SEC sets disclosure requirements, it does not evaluate the accuracy of the reports. The reports are viewable by the public on the SEC's EDGAR website.
A financial statement includes details on various aspects of the sales, operations, and financial sustainability of a business by providing a record of its gains, losses, strengths, and weaknesses over a specific period of time.
Financial statements are important because they can help business owners and prospective investors make better decisions on the long-range viability/strengths of a company.
