By Bryce Welker, a CPA and CEO of multiple companies, including Accounting Institute of Successful CPAs.
Income statements, balance sheets and cash flow statements. If you’re running a business, you probably have some knowledge of basic financial statements and how to use them. But do you know why they’re essential for entrepreneurs to use as a guide for growth?
If the answer is no, you’re not alone!
So many busy business owners get caught up in the grind and never bother running reports or analyzing much other than the bottom line. When using financial statements isn’t part of the strategy, the likelihood of becoming one of the many of businesses that make it to the 10-year mark is slim.
Thankfully, you don’t have to be a guru to understand fundamental financial statements and harness your power as an entrepreneur or executive.
As a CPA and CEO of several companies, I’d like to share an overview of three main types of financial statements, why they should matter to you and what you can do with the information on each.
Analyzing Income Statements
Financial statements are like a snapshot of your business’s overall financial health. They help you determine where you are and plan your next moves. From net worth numbers to profit projections, understanding financial statements is vital to gauge your strength in the market—and your weaknesses.
Income statements can be used to identify revenue and expenses, evaluate profitability, provide information to stakeholders and plan for the future.
They usually include revenues, expenses and profits or losses incurred over a specific period of time. Also called profit and loss statements, they’ll show you how much has been made, how much has been spent and where you’re sitting financially.
When reviewing an income statement, you’ll find information linked to any assets, liabilities, equity, owners’ investments and distributions to owners. It also includes revenues, expenses, gains/losses and comprehensive income.
Need to borrow money to increase production, launch a new product or market your current services? This critical information can be presented to those interested in your business. Again, income statements will be your best friend as they illustrate your business’s ability to pay off liabilities.
Bringing In Balance Sheets
Commonly confused with income statements, balance sheets are reports showing a company’s assets, liabilities and equity at a specific time. Balance sheets can be used to monitor financial health over a period of time, make decisions related to debt and investments, and attract new investors and talent.
If you’re looking at a balance sheet for a business, you can do a few things with it.
For one, you can analyze liquidity and determine whether there are enough short-term assets to cover short-term debts. This is done by comparing the business’s current assets to its current liabilities.
You can also evaluate efficiency by looking at the asset turnover ratio. In other words, are you using your assets in an efficient way that leads to more money generated? Finally, you can use balance sheets to assess solvency and answer the question, “Do we have enough assets to cover long-term debts?”
All of these uses will lead to one thing: a better overall picture of a business’s financial health. From there, you can make big decisions. For example, because they help pinpoint risk, balance sheets can help you decide whether you can afford to sink more money into capital or need to keep more cash on hand. They can also be used to secure private equity funding and prove that you can repay what you want to borrow.
Finally, these financial statements can help you attract and keep new talent. Employees want to know that their jobs are secure. After all, not many top-of-the-line employees are going to want to work for a business drowning in debt.
Considering Cash Flow Statements
The third part of the financial statement trio is a cash flow statement. Cash flow statements can be used to track inflows and outflows and find ways to improve a business’s financial position to achieve long-term goals.
Like the other two types, it analyzes this information over a certain period of time. So consult a cash flow statement if you want to know what you’re making and spending.
When predicting possible pitfalls and hiccups that might come up down the road, a cash flow statement can help you do this, too. Cash flow statements are really good for helping business owners and managers find areas to improve.
Let’s say you own a taco truck chain, and you’re preparing a cash flow statement for the past year. You notice that your business had a negative net cash outflow for the year. You know this means you’ve spent more money than you’ve brought in. However, you want to use this information to make decisions about your business going forward.
What can you do?
Well, first, you’d analyze your inflows and outflows. Were your primary sources of cash inflows from customer payments? Did a lot of your money come from loans? What were your main cash outflows? Did you spend most of it paying your suppliers, employees or maybe rent?
Once you have this information, you’ll be able to formulate a plan to get the business back on track and out of the red.
Final Thoughts
Financial statements are essential tools for every entrepreneur. Not only will they provide you with a comprehensive overview of the financial performance of your business, but they’ll also help you make informed decisions for the present and future.
You can use income and cash flow statements and balance sheets to monitor financial health in a way that just isn’t possible otherwise.
Still not sure where to begin? One of the best ways to begin is just to dive in. Choose a financial statement to focus on, run the report and start analyzing. If nothing else, you’ll walk away with more knowledge about your business and the best strategies for moving forward.
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