What Are Financial Statements 101: A Guide for Business Owners
What are Financial Statements and What Business Owners Should Know?
Those who are not conversant with business concepts may often ask two questions: What are financial statements and what are financial statements used for.
Understanding company financial statements requires knowledge of financial reporting, a vital process for businesses, accountants, investors, and other stakeholders. Financial statements are important information that shows organizational financial performance over time. Government regulatory agencies also mandate and monitor financial reporting for a variety of good reasons. Financial statements are the cornerstone of financial reporting.
So what are financial statements? Why are financial statements important? What is included in a business financial statement?
These important questions as well as how to read financial statements are the main focus of this post.
What Are Financial Statements?
Different writers are likely to use different words in addressing the question: What are financial statements? Basically, company financial statements are documents prepared to report the business activities and the financial performance of a company for a particular accounting period, e.g., one year. They are often audited by government agencies, accountants, companies, etc. to ensure they are accurate and also for financing, investment, and/or tax reasons.
Why are Financial Statements Important?
You may often have heard people asking: What are financial statements? That’s a sensible question to ask because financial statements are crucial to the business world and even beyond. The importance of financial statements are the fact that they contain a lot of information and numeric data on a company’s financial state. By going through the financial statements of a business, stakeholders such as investors, regulators, accountants, auditors, shareholders, and creditors have a greater understanding of the overall financial performance and health of that business for that particular period.
Moreover, financial statements help business owners have a better understanding of their bottom lines in order to make smarter business decisions. In today’s highly digitalized business environment, tools such as bookkeeping software can greatly assist in simplifying the communication process between sharing important documents with clients.
One good example of the importance of financial statements of business is in the area of funding. A small business seeking external funding from investors or financial institutions will usually have its financial statements thoroughly scrutinized by these potential lenders to see if the company meets their funding requirements. In the U.S., it is legally required that public companies publish their financial statements in an annual report.
What is Included in a Business Financial Statement?
By now, the explanations above should satisfy the curiosity that made you ask the question: What are financial statements? However, answering that question can inevitably lead you to also ponder about what is included in a business financial statement, and eventually toward how to make financial statements.
Here are some financial statements basics that typically contain information about a business’s:
- Accounting policies
- Management status
- Economic resources and obligations
- Earning capacity
- Potential cash flows
Types of Financial Statements
Broadly speaking, any accounting document or record that conveys information about the financial activities or transactions of an organization within a particular period is a financial statement. This should be noted when considering the topic: What are financial statements? However, the three most commonly used accounting statements are discussed below.
A balance sheet or statement of financial position (SFP) is a presentation of a company’s “book value” that enables readers to see what resources are available for a business and how they were financed as of a particular date. A balance sheet is the most important aspect among all financial statements in accounting. It shows the organization’s assets, liabilities, and owners’ equity. Information on a balance sheet can be used to compute rates of return and evaluate capital structure via the accounting equation:
Assets = Liabilities + Owners’ Equity
Assets are resources of quantifiable value owned by a company
Liabilities are all debts owed by a company (such as taxes, outstanding payroll expenses, rent and utility, and bonds payable).
Owners’ equity refers to a company’s net worth. It’s the sum of money that will remain if all assets are sold and all liabilities paid. This sum belongs to the shareholders, — who may be private owners or public investors.
Because the balance sheet does not include information on trends, it is necessary to study other financial statements, including income and cash flow statements, in other to have a full comprehension of a company’s financial state.
An income statement or profit and loss (P&L) statement is a documented summary of the cumulative impact of a company’s revenue, expense, gain, and loss transactions for a specific period. It is often made public as part of quarterly and annual reports and contains financial trends, business activities (revenue and expenses), and comparisons over particular periods.
The following information is usually included in a typical income statement:
- Revenue: money earned by a business
- Expenses: money spent by a business
- Costs of goods sold (COGS): the direct costs a business incurs to produce the goods it sold
- Gross profit: Total revenue less COGS
- Operating income: Gross profit less operating expenses
- Income before taxes: Operating income less non-operating expenses
- Net income: Income before taxes less taxes
- Earnings per share (EPS): Net income divided by the total number of outstanding common shares
- Depreciation: The degree to which assets (for example, aging equipment) have lost value over time
- EBITDA: Earnings before interest, taxes, depreciation, and amortization
Stakeholders such as accountants, investors, and other business professionals indulge in regular review of income statements to:
- Gain insight on how well their company is faring: Was the period in question profitable? How much did the company spend on producing each product? Does the company have cash to invest back into the business?
- Determine financial trends: When did the business incur the highest costs? When did it incur the lowest costs?
Cash Flow Statement
A cash flow statement or statement of changes in financial position (SCFP) mainly provides detailed information on a business’s cash movements during an accounting period. It serves as an indication of an organization’s ability to operate in the short, medium, and long term, based on its cash incomings and outgoings.
Cash flow statements are usually grouped into three sections:
Cash Flow from Operating Activities
Operating activities provide information about cash flow generated once the company delivers its regular goods and/or services. It includes both revenue and expenses.
Cash Flow from Investing Activities
Investing activity is cash flow generated through the purchase and sale of assets (using free cash rather than debt) usually in the form of tangible assets (such as equipment, houses, and vehicles) and intangible assets (like intellectual property such as patents).
Cash Flow from Financing Activities
Financing activities record cash flow derived from both debt and equity financing.
It’s necessary to highlight the difference between cash flow and profit. While the former refers to a company’s cash incomings and outgoings, the latter refers to the amount remaining after expenses are subtracted from revenues. Both are important numbers for business owners to know since they help decision-making.
Ideally, a positive cash flow is desirable because it is an indication of a company’s financial stability and ability to grow. However, a positive cash flow does not necessarily imply profitability, which is why business owners should also analyze balance sheets and income statements.
How to Read Financial Statements
Thus far, this article has managed to, among others, answer the following:
- What are financial statements?
- What is included in a business financial statement?
Which leaves us with how to read financial statements meaningfully. Well, financial statements present a lot of vital information that can be read or interpreted in a variety of ways. A financial statement for business for the current period can be compared to those of prior periods to better understand changes over time. For instance, comparative income statements report a company's income in both the previous and current periods. Knowledge of the year-over-year change in income is a good indicator of the financial health of a company.
Financial statements can also be read to compare the results of competitors or other companies in the same industry or other industries. By comparing the financial statements of various companies, accountants, economists, finance experts, investors, and other analysts can have an idea of top-performing and struggling companies.
Organize Your Financial Statements With Qbox
Qbox is a CoralTree product that allows business owners and others to remotely store, read, and share Quickbooks files and other documents with multiple users simultaneously with ease. Qbox works with over 300 programs including QuickBooks, and Microsoft.
Here are some features of Qbox:
Locking and Syncing
Locking and syncing is a revolutionary technology patented by CoralTree. Share QuickBooks financial statements, MS Access, Word, Excel, PowerPoint, PDF, JPEG, PNG, TIFF, and other file types with multiple users over the internet. Collaborate efficiently by sharing your changes automatically. Qbox locks the file to ensure that the changes you make are protected. When you are done, Qbox syncs the changes and releases the lock automatically so another user can take control of the lock to make his own changes. When one user is in control of the file lock, another user can only view the file, but cannot make any changes to it.
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If your company particularly works with QuickBooks Desktop, then you’ll find Qbox an indispensable tool. Qbox, unlike all the other cloud services, was created with QuickBooks data in mind. Sign up to Qbox today and receive 30 days free if you are a first-time user!