Understanding financial statements including income, balance and cash flow on the corporate level takes both time and training. Knowing how to read these are vital for an investor looking at putting money into a company. However, as a small business owner, its important to have a general concept of all three. These are all covered under general accounting methods which are also important to understand. Here’s a shortened summary taken from Investopedia:
Balance Sheet …A company’s balance sheet provides information on what the company is worth. The balance sheet reports the totals of a company’s assets, liabilities and shareholders’ equity on a specific date, and it mimics the accounting equation expressed as assets = liabilities + shareholders’ equity…the balance sheet reflects the direct relationship between these transactions. Instead of showing individual accounting transactions, the balance sheet acts as a snapshot of the company’s accounts at the end of an accounting period. An increase or decrease in assets due to profit or loss is transferred to the balance sheet directly from a company’s income statement…
Income Statement … A company’s income statement reports the level of revenue a company earned over a specific time frame as well as the expenses directly related to earning that revenue. Companies first list gross revenue from product or service sales, and then subtract any money not expected to be collected on specific sales due to returns or sales discounts. This results in the company’s net revenue. All expenses related to the cost of sales are subtracted from net revenue to reach gross profit. All operating expenses are then deducted from that total, resulting in operating profit before interest and income tax expenses. Net earnings or losses are listed as the bottom line of the income statement after expenses for interest and taxes are deducted…
Cash Flow Statement… The cash flow statement reports any cash inflow or outflow over the course of the accounting period. This financial statement highlights the net increase and decrease in total cash on hand for the accounting period…broken down into different sections, including operating, investment and financing activities….
Understanding Financial Statements – simplified version
For a simple summary from a small business perspective, lets start with the income statement. As a small business owner you only have to do an income statement. For example: All book keeping records done over the year will result in your basic income statement. This breaks down all the money coming in (revenue) and where it goes out (expenses). Then a summary of assets (what you own that helps the company) and liabilities (what you must pay out), and any profit and loss from these will be transferred to a balance sheet.
The balance sheet gives a general overview of what your company’s net worth, including assets, liabilities and shareholder’s equity at the end of each year. Shareholders equity = 1. the total assets minus total liabilities or 2. Current cash amount of total publicly held shares in the company + Retained earnings – Treasury Shares (Not public but company owned shares).
Basically, your balance sheet tells you how much money you have (cash and assets like cars, machinery buildings etc.) and what you owe (expenses, loans, interest payments etc).
The Cash Flow Statement information also comes from the income statement. But it only includes the transaction level changes in net profit or loss. The cash flow statement tells you how well you are handling your cash in and out of the business. While the balance sheet basically tells you how your assets and liabilities are doing.
Yet for new business owners, just focus on your income statement. The other two will come as you build equity and start generating cash profit. For investors, the Balance Sheet really tells how the company’s doing and how to value the company.
Cash Flow statements show how well they handle their cash. However, understanding income, balance and cash flow statements on a deeper level can help you understand the true nature of your finances and how to keep them on track.
Just as a reminder. Hiring employees adds to overhead costs and another layer of payroll expense. Which has a large effect on your income and cash flow statements (outside large asset purchases). When it comes to handling our finances, its important to establish a robust data management system.
To help with understanding financial statements, I preferred using Quickbooks, though some prefer Peachtree. However, one way to more fully understand this topic, is to take time and go through the tutorials and instructional features of these programs. They provide practical hands on approach to learning various accounting principles.