Making Sense of Financial Statements

To determine the financial health of your small business, it's important to take a proactive approach in order to identify issues before they become significant problems and to identify areas of profit. Relying solely on your bank account overlooks the most powerful financial tools at your disposal: the Income Statement, Balance Sheet, and Cash Flow Statement. These statements provide a comprehensive view of your business and are essential for long-term success.

However, as a small business owner, you may not have expertise in accounting. The following is an overview of the key financial statements and how they can be used to make decisions.

Income Statement

The Income Statement, also known as the Profit and Loss (P&L) Statement, is useful for gauging the overall performance of your business. A well-maintained Income Statement can detail how profitable your business is and provide direction for increasing profitability by cutting unnecessary expenses or focusing on certain products or services. It can also show your profits to indicate the potential for reinvesting in your business, paying your own salary, or covering outstanding debt. Investors may review your Income Statement to assess the level of risk involved in extending credit or capital.

Comparison Reports

Comparison reports of your Income Statement can provide even more useful information. For example, you can compare your Income Statement from this June to your Income Statement from last June or your year-to-date for this year to your year-to-date from a year ago.

Balance Sheet

The Balance Sheet summarizes key financial information on a given date and is a good indicator of stability and liquidity. Its main components include business assets, liabilities, and owner's equity. While it may seem overwhelming, the Balance Sheet can help determine the net value of your business, current and long-term debt, asset management and liquidity ratios, and changes in cash, accounts payable and receivable, equity, inventory, and retained earnings. Comparison reports are also available for the Balance Sheet to see if you're worth more now than you were the year before.

Cash Flow Statement

The Cash Flow Statement is crucial for identifying whether your business has enough funds to stay afloat and for determining if you need to secure additional capital to purchase inventory or fund seasonal expenses. It allows you to account for delinquent or missing payments, but it can be difficult to understand. However, it can be produced with accounting software or provided by an accountant upon request.

If you want to learn more about financial statements, visit our Learning Center for information on how monthly accountants can use financial statements to offer advice, red flags to look out for on self-prepared statements, and other accounting, tax, and payroll topics.