All small and medium-sized businesses must be well informed to survive in today’s competitive business environment. One of the imperative competencies they should develop is to read and interpret financial statements. Comprehending critical financial statements such as balance sheet, trial balance, cash flow statement, profit &loss statement, and more is paramount to the success of your business. Indeed, these are the reports that a business needs to ensure its competitiveness.
Running a company without a proper understanding of these financial statements is like driving a vehicle without a dashboard. You need constant information on different parameters such as market share, cost of production, market demand, investments, competitive activity, statutory levies, cost of capital, and more. Other vital financial information that you need include costs, revenues, business investments, loans, and salaries.
These details are available in your business financial statements and can be interpreted to get a better view of your business performance. Here are the important financial statements that you, as an entrepreneur or business manager, must know.
1. The balance sheet
Most financial experts say that the balance sheet tells your business financial story. They warn against looking at your company’s statement by itself. This is because you can look at the report and see all the good things that point towards business growth – low costs, high revenue, and big profits.
The balance sheet is a financial report that shows the value of all the assets your business has accumulated, the total amount of money you owe your creditors, and all initial investments, including equity, build up over a particular period.
A professionally created balance sheet should offer essential indicators such as the working capital, debt ratio, sales & inventory ratios, and cash conversion cycle. You need this information to understand the financial health of your business. This information could also help you make the necessary adjustments and implement policies that could drive business growth.
2. The income statement
This financial report tells you whether or not your business made a profit. It compares the amount of money spend and the revenue earned. It itemizes all sales made, costs that are directly related to sales (cost of goods sold), and the company’s operating expenses.
The income statement contains two distinct sets of transactions. The first set of transactions is the company’s operating revenues and expenses. These are the transactions that are directly related to your company’s operations. The second set of transactions is non-operating revenues and expenses. This is what you owe or charge and isn’t related to business operations. Tax is an example of a non-operating expense.
Note that you can tailor your company’s income statement to suit the specific needs of your business. Also, you can apply different filters to get a better understanding of where your business income and expenses originate. For example, perhaps you have two income streams. One for selling cosmetics and the other for selling hair products. Separating the income statements for these two revenue streams will give you a better understanding of your source of income and expenses.
Some of the essential indicators in a company’s income state include revenue growth rate, burn rate (how quickly you spend cash on your business), net profit margin, revenue growth rate, and net profit growth rate.
3. Statement of cash flow
This financial statement bridges the gap between your company’s income statement and the balance sheet. It shows all the activities of the most imperative financial item – your company’s cash. It tells where your cash went. Remember, a profit and loss statement or balance sheet says nothing about the principal amount you paid to the bank. Actually, you may have good profits, but that amount you pay to your bank monthly could be throwing your business off balance.
The statement of cash flow offers entrepreneurs and business managers the insights they need to begin making excess cash. Sure, making profits is important. However, profits are one of the things that create cash. There are other cash making opportunities too. For instance, if you pay less for a capital piece of equipment, you will be creating cash while spending money. Collecting receivable faster from your clients also means you are making cash.
Lastly, your company’s cash flow statement can help in the process of making financing decisions. Remember, adding inventory requires cash, purchasing capital equipment uses cash too, acquiring more customers requires cash, and growing the overall capacity in your company uses money too. When making these decisions, you need reliable information about your business’s money, and the cash flow statement gives you exactly that.
Beyond the numbers
You won’t know what these numbers mean and how to manipulate them without a little practice. This is why you need a finance expert. Rather than waiting until the tax season to start reviewing your business performance and money, it’s recommended to stay on top of your operations and cash. This will help you to make the necessary adjustments based on monthly fluctuations and plan effectively for emergencies and unexpected changes.