Preparing your financial statements is vital for entrepreneurs. However, a 2023 SME survey revealed that 70% of business owners don’t know how to analyse these documents to inform business decision-making. Financial reports may seem daunting at first, but breaking them down into their core components can demystify the process and help entrepreneurs embrace this valuable data.
This article will explore the three main financial statements –– the income statement, balance sheet, and cash flow statement. It will give you the knowledge to interpret and use these essential tools to your business’s advantage. Read on to learn more.
Income Statement: The Story of Your Profit and Loss
The income statement (also known as the profit and loss statement) provides insight into your company’s profitability and operational efficiency, identifying areas where you’re excelling, or where you may need to cut costs to spur growth.
It’s comprised of four main components, including:
- Revenue: The income earned from your company’s primary activities.
- Expenses: The costs of performing core business activities, such as direct costs, such as Costs of Goods Sold (COGS), and indirect costs, such as employee salaries, warehouse rent, utilities, etc.
- Gross Profit: This describes the ratio between Revenue and COGS
- Net Income: This figure represents your business’s bottom line (i.e., your company’s profit after all expenses are deducted).
Balance Sheet: Overview of Your Financial Health
The balance sheet offers a snapshot of your company’s financial position at a specific point in time and is structured around the following accounting for entrepreneurs equation:
Assets = Liabilities + Shareholders’ Equity
- Assets: Resources owned by the company, including inventory, cash, and equipment.
- Liabilities: Debts and obligations, including loans and Accounts Payable
- Shareholders’ Equity: Net worth of the company, representing the owner’s stake.
Understanding your company’s balance sheet will help understand your company’s liquidity, solvency and overall financial health. Learn more about key metrics to monitor your company’s financial statements here.
Cash Flow Statement: Money Movement
Understanding this key aspect of your financial statement will help you plan for future cash needs and ensure your business remains viable in the short and long term. The cash flow statement is divided into three main sections including:
- Operating Activities: This tracks cash flow related to your business operations over a set period.
- Investing Activities: Cash flows for buying or selling long-term assets.
- Financing Activities: The cash flows relating to borrowing, transactions with owners and repaying debt. Learn more about how accountants can help you secure business funding in this previous article.
Accounting for Entrepreneurs: Analysing Financial Statements
All of the above financial statements are interrelated and help entrepreneurs build a comprehensive understanding of their financial health to inform future decision-making. For example, you can analyse them to help you with the following:
- Identify Trends: Compare financial statements over time to spot patterns in cash flow, revenue and expenses, improving performance over time.
- Analyse Profitability: Use the income statement to evaluate pricing strategies, cost management and your business model’s overall effectiveness.
- Manage Cash Flow: Identify shortages or surpluses in your cash flow statement to help you avoid liquidity issues.
- Benchmark Performance: Compare your financial statements with industry standards to monitor your company’s performance in relation to competitors.
INAA: Connect with Accounting for Entrepreneur Experts Worldwide
Understanding financial statements is an essential skill for entrepreneurs navigating an increasingly competitive environment.
Connecting with accounting and auditing professionals from INAA can also help you demystify accounting for entrepreneurs, ensuring that you can drive your business to new heights. Learn more about the INAA’s benefits for clients here. Alternatively, if you’re interested in connecting with accounting and auditing professionals worldwide, join INAA today.