Do you know what financial statements are? I’m sure you’ve heard of the balance sheet, income statement, cash flow statement, and even the statement of retained earnings (a.k.a. statement of changes in equity). These documents provide information about the financial position and performance of a business. They are very useful for doing your financial and accounting year end closure, and are used for doing financial analysis of your business. With the information gathered from financial statements, you can make business decisions clearly and stay up-to-date with your figures.
This article will explore the three main financial statements: the balance sheet, the income statement, and the cash flow statement. These three documents complement each other to provide a comprehensive picture of a business, and its (hopefully!) solid financial footing. It is essential to understand these terms well to ensure good management of your company, and be able to use your accounting software efficiently.
The balance sheet, also known as statement of financial position, is a snapshot of your company at a given moment of its existence. It is used to see what you own vs. what you owe to your creditors.
In accounting, the equation for calculating your balance sheet is:
Assets = Liabilities + Equity
Equity basically means the assets or holdings of the company owner. It shows the deductions made, the contributions, and what the owner had in any given financial or fiscal year.
For more key accounting terms, you can check out our practical accounting glossary, coming soon to Kiwili!
Here are a few key terms you might come across:
- Liabilities : include debt and long-term debt, rent, tax, and utilities, wages and dividends.
- Shareholders’ equity : is the total assets of a company minus its total liabilities. This is the amount of money that would be returned to the shareholders if the company’s assets were liquidated and its debt was paid off.
- Retained earnings : come under shareholders’ equity as a percentage of net earnings that are not paid to shareholders as dividends.
- The annual report : a highly reliable and audited document, contains a company’s financial statements. This is the financial data used by analysts to explore a company’s performance, and make predictions about the direction of the company’s stock price in future.
As for the income statement,also known as profit and loss statement or financial result, it effectively demonstrates the income generated and expenses incurred during any given financial year.
Revenues – Expenses = Net Income
This is useful for knowing on what amount of money the company owner(s) must pay tax.
Once you have produced these two financial statements, you can do what is called a trial balance. A trial balance allows us to check for any errors in the accounting entries. The debits should be equal to the credit:
Debit = Credit
Did you know? An income statement is often presented with one to two other years of data alongside it, for comparison purposes.
Finally, there is the cash flow statement, how much cash or cash equivalents are going out. Another snapshot of the money which comes in and out of your company. In short, it’s a bit like a photo of your company’s bank account. Cash flow goes towards a company’s debt obligations, day-to-day operating expenses, and to fund investments for growth, expansion and development.
Don’t miss our advice for managing your cash flow efficiently in our article on cash flow, coming soon to Kiwili.
So, now we’ve covered what financial statements are, written records conveying the business activities and financial performance of a company, who are they for exactly? As mentioned above, their primary use is internal, for the company itself to examine their financial position, however financial statements are typically also audited by government agencies, accountants, and other firms, etc. to ensure accuracy when the time comes to pay tax.
On the other side of the coin, if your company is seeking growth and expansion (and these days, who isn’t!), think about how useful these financial statements can be for finance or investment purposes.
Once you have the full picture of what’s happening within your company, you will have a number of options for how best to proceed.
In the case described below, given that the company is operating at a loss, the owner could be questioning whether to diversify his activities to create other sources of income. He could also decide to change his billing method, meaning that he would no longer have 14 day accounts receivables. Alternatively, he could decide to try his hand at approaching a financial institution to lend him some money.
Financial statements are used to guide you in your entrepreneurial choices, monitor and manage cash generated, carry out your bookkeeping and generate financial reports.
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