As a small business owner, your financial statements are crucial for making sound decisions about the future of your company. It’s not just about having accurate numbers, though. Understanding how to analyze your finances is also essential for making informed choices. By examining your financial statements, you can get a total view of your business’s financial health, and spot potential issues or opportunities that might have otherwise gone unnoticed.
With our comprehensive guide, we’ll explain all of the key elements associated with key financial statements—including how to understand them.
Three major types of financial statements that every franchise and small business owner should understand:
– Balance sheets
– Income statements
– Cash flow statements
Each of these documents serves a different purpose, but when analyzed together they show the big picture behind a company’s financial situation.
1 | Balance Sheets
Think of a balance sheet as your company’s financial GPS. It reveals a total view of your organization’s resources and financing at a specific moment in time. Not only does it highlight your assets, liabilities, and owners’ equity, but it also offers insights into calculating rates of returns and scrutinizing your capital structure.
Essentially, a balance sheet shows what you owe, what you own, and how much your shareholders have invested – all crucial components in understanding your company’s financial health.
Balance Sheet Equations To Know:
Assets = Liabilities + Owners’ Equity
Owners’ Equity = Assets – Liabilities
Liabilities = Assets – Owners’ Equity
Assets are resources your company owns or controls that have economic value. They can be divided into two categories:
Long-term investments can be tangible, such as property, plant, and equipment, or intangible, such as patents, trademarks, and goodwill.
Current or short-term investments like cash, accounts receivable, and inventory.
Liabilities are considered what your company owes to others from transactions or events. These include instances of paying back a loan or fulfilling a contractual obligation. Some other examples of this include accrued expenses, accounts payable, and loans.
Your owners’ equity represents the residual interest in an asset of your company after deducting its liability. Meaning it’s the value that belongs to the owners of the company. Owners’ equity can be divided into two main categories:
Contributed capital, which represents the amount of capital contributed by shareholders/investors or owners.
Retained earnings, which represent the amassed profits or losses of the company that have not been distributed to investors or owners.
When analyzed from within a company, it provides a pulse on the success (or failure) of its efforts. But taken from an external point of view, it reveals the resources and financing behind a business. It can be the first point of reference for interested parties to evaluate a company’s viability for investment.
2 | Income Statement
Want to see much money your business made or lost during a specific period of time? You’ll see that on your income statement. Otherwise called a profit and loss statement, it captures your company’s revenues, expenses, gains, and losses.
Let’s break it down. The income statement reports:
Revenue: This is the money your company earns from selling goods or services.
Expenses: The costs your business incurred to run its operations, such as salaries, rent, utilities, and advertising.
Cost of goods sold (COGS): Expenses incurred in producing or supplying goods or services that are sold to customers.
Gross profit: The profit remaining after deducting COGS from revenue.
Operating expenses: These include salaries, rent, utilities, and advertising. They are subtracted from the gross profit to calculate the operating income.
Operating income: This represents the profit earned from your company’s core business operations before non-operating expenses and income.
Net income: Final profit or loss for the period, and it reflects the total earnings or losses of your company.
Analyzing your income statement can help you see how much money your business is making or losing, and where that money is coming from or going. It also allows you to identify areas where you may be spending too much money and find ways to cut costs.
If revenue is increasing, but your expenses are also going up, you may need to re-evaluate your pricing strategy or find ways to reduce your costs. If your expenses are decreasing, but your revenue is staying the same, you may be able to increase your profits by increasing your prices or investing in marketing and advertising.
3 | Cash Flow Statement
A cash flow statement reveals the ebbs and flows of cash movements during a specific period, providing insight into your business’s stability and potential longevity and giving you a clear picture of its cash flow trajectory.
It is divided into three sections that show where the cash is coming from and going to:
Cash flow from operating activities, which includes regular business activities like expenses and revenue.
Cash flow from investing activities, which includes buying or selling assets like property, vehicles, or patents using free cash instead of debt.
Cash flow from financing activities, which includes cash flow related to debt and equity financing.
It’s important to understand the difference between cash flow and profit. Cash flow refers to the movement of cash in and out of a company, while profit is what’s left after expenses are subtracted from revenue.
A positive cash flow from operating income is a good sign because it shows financial stability and potential for growth. BUT, that only sometimes means a company is profitable. Be sure to consult your other financial statements we already discussed to determine this.
As a small business owner, routine review and analysis of your financial statements is a critical step in optimizing financial performance. Though, we understand that navigating can be challenging, especially if you don’t have a strong background in finance. That’s where leveraging financial senseis, like us, can help.
At Ceterus, we offer top-of-the-line benchmarked reporting and accounting services that can provide you with a clear view of your financial performance and identify areas where you can make adjustments.
Take your finances off your plate and keep focused on your future as a small business owner. Talk to an expert at Ceterus today.