Understanding the Financial Statements
A company's financial statements are extremely valuable to understand the company's financial condition. Financial statements provide information about the company at a point in time. This information can be used in many different ways.
Financial statements are used by banks to approve credit to a business, to raise equity from investors or by the owners if they are interested in expanding or opening up a second location.
The overall health of a company may be revealed by financial statements.
Below are the basic elements that make up the complete financial statements.
1. Balance Sheet
2. Income Statement
3. Cash Flow
4. Supporting Schedules
Using these statements not only helps you understand your company, but it gives you an advantage since you can use your knowledge to grow your business and make changes accordingly.
The Balance Sheet
Further reading: Balance Sheet
The balance sheet comprises of the assets (what you own), liabilities (what you owe), and owner's equity (the owner's contributions plus any net income or losses throughout the years).
The balance sheet follows the simple equation of:
Assets = Liabilities + Owner's equity
If the balance sheet is not in balance then it is wrong. When a balance sheet has too much debt when compared to the assets, then the balance sheet is considered weak and you will have a hard time if you are looking for loans. Your debt to equity ratio will easily tell you what your percentage is.
Further reading: Income Statement
The income statement tells you how much profit your business is currently making. It is also known as the profit and loss statement or P+L.
The income statement follows the simple equation of:
Profit (loss) = revenue - expenses
Revenue is your income from sales or other income such as interest of miscellaneous income that is not from the course of your natural business. The expenses are made of operating expenses such as advertisement, payroll, utilities, etc.
Further reading: Cash Flow
The cash flow statement is one of the most telling financial statement. This statement shows the movement of cash in the business. A true cash picture is provided when reviewing the cash flow statement.
The cash flow has three sections:
1. Operating activities (expenses and income related to the normal course of business)
2. Financing activities (money raised for the operations or paid towards debt)
3. Investing activities (money used in purchases/sales of equipment/investments )
Supporting documents provide more insight into the income statement. These supporting schedules provide more detail into different generalized expenses.
Supporting schedules include:
Statement of Cost of Good Sold
Statement of General and Administrative Expenses
Statement of Selling and Operating Expenses
These statements provide a breakdown of the totals listed on the income statement.
The balance sheet, income statement, cash flow statements and supporting schedules provide necessary information to the health of the business. The data is necessary to provide investors and banks with the right information to make informed decisions.
How Are They Connected?
All three statements are key in understanding and analyzing your company's performance. The Balance sheet and cash flow focus on capital management regarding the assets and liabilities of the company. The income statement provides a deep understanding into the operations of a business.