What is a Financial Statement?
A financial statement is a formal record summarising a company’s financial activities and position, typically on a quarterly or annual basis. It’s a document that shows how much money a company has, where it came from, and where it’s going. Think of it as a snapshot of their financial health. These statements help investors, creditors, and even the company itself to understand its financial performance and make important decisions.
A financial statement consists of three main components:
1. The Balance Sheet, is like a company’s financial photograph, showing what they own (assets) and what they owe (liabilities) at a specific point in time. .
2. The Income Statement, is like the company’s report on how much money they made (revenue) and how much the spent (expenses) over a certain period, usually a year or a quarter.
3. The Cash Flow Statement, tracks the actual cash coming in and out of the company from pg operating, investing, and financing activities.
These statements collectively offer a comprehensive view of a company’s financial standing and operational efficiency.
Let’s take a quick look at each component in more detail.
Balance Sheet
The balance sheet is a financial statement that presents a snapshot of a company’s financial position at a specific point in time.
It highlights the fundamental equation: Assets = Liabilities + Equity.
- Assets encompass resources owned by the company, such as cash, inventory, and property.
- Liabilities include what is owes to others like debts and bills you haven’t paid yet (payables).
- Equity represents the residual interest of the owners in the company’s assets.
The balance sheet serves to showcase the company’s financial health, aiding stakeholders in assessing solvency, liquidity, and overall worth.
Income Statements (Profit and Loss)
An income statement, also known as a profit and loss statement, show how much money the company has made and how much it has spent over a specific period.
It outlines:
- Revenue, which is the total income generated from sales or services.
- Expenses encompass costs incurred to operate the business.
The income statement shows whether a company is making a profit (money left over after expenses) or a loss (spending more money than it’s making) over a certain timeframe.
The income statement provides insights into a company’s ability to generate profits, manage expenses, and maintain sustainable operations. It’s a crucial tool for assessing profitability and making informed financial decisions.
Cash Flow Statements
Cash flow is like the lifeblood of a business. Without sufficient cash flow, a business can’t pay its bills, cover operating expenses, or even stay open. It’s essential for the day-to-day operations and overall survival of a company.
A cash flow statement tracks the movement of cash in and out of a company over a specific period, like a month, quarter or year.
It categorises activities into three key elements: operating, investing, and financing.
- Operating activities involve cash generated from core business operations, like sales and expenses.
- Investing activities encompass cash flows related to buying or selling assets.
- Financing activities involve cash transactions with investors, such as loans and equity investments.
The cash flow statement helps you to see if a company is managing its cash well to ensures that financial obligations are met, opportunities can be pursued, and unexpected challenges can be managed effectively.
The Importance of Financial Statements
Financial statements hold significant importance for small businesses, serving as essential tools for assessing their financial health, making informed decisions, and attracting potential investors. These statements offer a comprehensive view of the company’s performance, aiding owners in understanding profitability, liquidity, and solvency.
- By analysing the balance sheet, small businesses can assess their assets, liabilities, and equity, providing insights into financial stability.
- The income statement helps in evaluating revenue generation, expense management, and overall profitability.
- Cash flow statements offer visibility into the company’s cash position and ability to meet financial obligations.
Moreover, these statements play a crucial role in attracting investors. Potential investors rely on financial statements to assess a company’s financial viability, potential returns, and risks.
Detailed and transparent financial statements instil confidence in investors, showcasing a company’s financial management practices and growth potential. Accurate financial reporting demonstrates a commitment to transparency, instilling trust and making the business more appealing to investors.
Overall, financial statements empower small businesses to make strategic decisions, demonstrate their financial health, and successfully attract investors for sustainable growth.
How to Prepare A Financial Statement
There are 5 key steps to preparing a financial statement.
Gather Financial Data
Collect all relevant financial data and records, including invoices, receipts, and bank statements. Use an accounting system to record financial transactions and ensure that the financial data is organised and categorised accurately.
Prepare the Balance Sheet
List all business assets and liabilities (both current and non-current), and the business owner’s equity accurately and truthfully. Ensure that the assets equal the sum of the liabilities and the owner’s equity.
Create the Income Statement
Record your revenue and expenses for the period so you can calculate net income or loss (revenues minus expenses).
Generate the Cash Flow Statement
Analyse your cash inflows and outflows from operations, investments, and financing, during the period, calculating the net change in cash.
Review and analyse the Financial Statements. Use the services of a professional, such as an accountant, to ensure accuracy and completeness.
Best Practices for Small Business Financial Statements
For a small business, the best practices for creating a financial statement are:
1. Ensuring accurate and reliable financial data
2. Maintaining consistency in recording and reporting practices
3. Preparing financial statements on a regular basis
4. Adhering to reporting deadlines and regulatory requirements
5. Engaging with an accountant or financial advisor for guidance
6. Ensuring compliance with accounting standards and regulations
Interested in a career in accounting or financial advising? Check out our courses available here at Monarch Institute!
Is your financial interest piqued? Are you interested in a career in accounting or financial strategy, to help out small businesses? Study with Monarch Institute today.
