Financial statements are an essential tool for understanding the financial health of your business. These reports distill some of the most important aspects of your business into digestible numbers that must be used to drive decision-making. If you’re doing your own books, chances are you’re reading over your own financial statements and making decisions accordingly. However, not every small business owner has a true understanding of the crucial documents they need to make fully-informed decisions. In this blog, we discuss the three main types of financial statements, and how you can better understand what you’re reading. 

The balance sheet 

The balance sheet provides a snapshot of your financials, demonstrating the assets and liabilities of your organization. Balance sheets are broken up into three general categories: assets, liabilities, and equity. 

Assets

Assets are anything that a company owns that holds current, future, or potential value. They can be broken up into three groups; current assets, fixed assets, and intangible assets. Current assets are short-term resources that are expected to be converted into cash within one year (e.g. cash, accounts receivable, inventory). Fixed Assets are long-term, tangible resources that are depreciated over time and contribute to the company’s income (e.g. vehicles, buildings, machinery, equipment, furniture, land). Intangible Assets are non-physical assets used over a long period of time (e.g. patents, trademarks, copyrights, customer lists, goodwill) .

Liabilities

Liabilities refer to any debts that a company owes to other people or businesses.  The first type of liability is called a “current liability.” This is any  short-term financial obligation due within one year or within a normal operating cycle (e.g. accounts payable, payroll liabilities, taxes, credit card payables, current portions of some loans). The other category of liability is a “long-term liability”, which is a financial obligation that is not due within one year or within a normal operating cycle (e.g. notes payable, bonds, leases, mortgages, loans).

 Equity 

Equity is the remaining value of the company once liabilities subtracted from assets. This indicates an ownership interest in business (e.g. stockholders’ equity or owner’s equity) resulting from capital contributions into the business and/or distributions out of the business, as well as the cumulative retained earnings of the business. It’s important to note that equity is only the “book value” of the company. It’s not the business' market value if it were to be sold. When selling a business, buyers usually pay more than the book value of the business based on things like the company’s annual earnings, the market value of tangible and intangible property it owns, and more.

Now that we’ve touched on our three categories, it is important to note that frequency is a major factor to consider in regards to your balance sheet. Based on what type of organization you’re running, you may need monthly balance sheets to properly understand your business as opposed to quarterly or even annual reports. Without regular, timely balance sheets, you can quickly lose sight of your organization’s financial status if you aren’t careful. There are also many tools out there that help you visualize this (and other documents) to tell a more compelling story than just numbers on a page. If you’re having to squint and try to wrap your head around your balance sheet, you aren’t alone, but would likely benefit from an outsider’s help refining your company’s finances. 

Income Statement (P&L)

The income statement, also referred to as a profit and loss statement, shows how profitable the business was over an accounting period, such as a month, quarter, or year. It is important to compare P&L statements from different accounting periods, as the changes in revenues, operating costs, and net earnings over time are more meaningful than the solitary numbers themselves. Together with the balance sheet, the P&L statement provides an in-depth look at an organization's financial performance. It shows how much the organization made (revenue) and how much it spent (expenses).The profit and loss (P&L) statements contain summarized information about revenue and expenses. Based on the standard operating procedure of a business, these statements are generated on a weekly, monthly, quarterly, or annual basis.

The P&L report also allows the company to assess revenue and expense trends, net income, and overall profitability – to then allocate resources and budgets accordingly. This document is required by the IRS to assess taxes on your organization’s profits. 

Cash Flow statement 

The statement of cash flows contains summarized information about how a company’s cash balance changed over a period of time. This statement is typically broken down into three categories. First is “cash flows from operations”, which are typical business activities: it’s the net income (or loss) of the business, adjusted for cash differences resulting from how long it takes to collect from customers, how long it takes to pay vendors or employees, or non-cash activities such as depreciation. Next is “cash flows from investing activities.” These are generally cash expenditures on fixed assets and other investments that are not part of  normal operations. The final category is “cash flows from financing activities” which consists of debt and equity transactions that either increase or decrease cash position (e.g. paying off a bank loan is a financing activity, as is receiving an outside investment from a venture capital firm).

The basic formula of a cash flow statement is:

End. Cash = Beg. Cash +/- Operating Activities +/- Investing Activities +/- Financing Activity

In summary, the cash flow statement contains summarized information about how a company’s cash balance changed over a period of time. This statement is typically broken down into three categories: Cash flows from operations, cash flows from investing activities, and cash flows from financing activities. 

The balance sheet metrics tell the story of your organization’s financial profile:how “liquid” it is, how “leveraged” it is, how well it’s turning revenue into cash, and how profitable it is relative to its assets or ownership. 

 P&L metrics can tell a story about how a company is trending, how profitable it is (or isn’t), and how well it is running its core operations. Other metrics can tell a story about the future growth prospects of a company, how efficiently it is running its sales & marketing program, and whether its business model is scalable. Financial statements can be very complicated without proper familiarity. If you have a hard time interpreting your organization’s financial statements, considering outsourced accounting or bookkeeping can help you see the whole picture and ultimately make the right decisions for your organization.

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finairo offers comprehensive outsourced accounting, bookkeeping, and finance solutions that empower your business to make informed decisions and maximize growth. Our experts have decades of operating experience across multiple industries and utilize best-in-class technology to ensure maximum data visibility, making it easy to understand your firm’s financial situation. 

Request a consultation to learn more about how finairo can help empower your business through accurate, timely, and insightful financial practices.