Financial statements can seem intimidating when you’re not an accountant.
Rows of numbers, unfamiliar terms, and multiple reports can make it difficult to know what information actually matters.
The good news is that you don’t need to be an accountant to understand the basics.
Financial statements can provide a useful picture of how your business is performing and help you make better decisions.
Three of the most important financial statements to understand are the income statement, balance sheet, and statement of cash flows.
The Income Statement
The income statement shows your business’s revenue and expenses over a specific period.
It can help answer a basic question:
Did my business make money during this period?
The income statement generally starts with revenue.
From there, expenses are subtracted to determine profit or loss.
For example, if your business generated $100,000 in revenue and had $75,000 in expenses, the business would show $25,000 in profit before considering other applicable items.
Looking at the income statement over time can help you identify trends.
Is revenue increasing?
Are expenses growing faster than sales?
Are certain expenses taking up more of your revenue than expected?
These questions can be more useful than simply looking at one month’s profit.
The Balance Sheet
The balance sheet provides a snapshot of your business at a specific point in time.
It generally includes three major categories:
- Assets
- Liabilities
- Equity
Assets are things your business owns or controls that have value.
Liabilities are amounts your business owes.
Equity represents the owner’s interest in the business after liabilities are considered.
The basic accounting equation is:
Assets = Liabilities + Equity
The balance sheet can help you understand the overall financial position of your business.
The Statement of Cash Flows
Profit and cash are not always the same thing.
A business can show a profit and still experience cash flow problems.
The statement of cash flows helps explain how cash moved through the business during a period.
It generally looks at cash from operating activities, investing activities, and financing activities.
For a business owner, understanding cash flow can be especially important because bills and payroll have to be paid with available cash, not accounting profit.
Look for Trends
One financial statement by itself may not tell the entire story.
Instead of looking only at the current month, compare financial statements over time.
You might compare:
- This month to last month
- This quarter to the previous quarter
- This year to last year
- Actual results to your budget
Looking at trends can reveal changes that might otherwise go unnoticed.
Pay Attention to Expenses
Revenue is important, but expenses deserve attention too.
A business may have strong sales while expenses are increasing just as quickly.
Review major expense categories regularly.
Look for unusual increases and ask whether they are temporary or part of a larger trend.
Don’t Ignore the Balance Sheet
Small business owners often focus heavily on the income statement.
However, the balance sheet can provide important information about debt, cash, accounts receivable, and other financial conditions.
A business with strong profits but increasing debt may require a different strategy than a business with similar profits and a strong cash position.
Use Financial Statements to Make Decisions
Financial statements are most useful when they help you make decisions.
You might use them to determine whether you can afford to hire another employee, evaluate whether expenses need to be reduced, plan for a major purchase, or determine whether your business is moving toward its goals.
The numbers become much more useful when you understand what they are telling you.
You Don’t Have to Read Them Alone
If your financial statements don’t make sense, you’re not alone.
An accountant can help explain what the numbers mean and identify trends or issues that may deserve attention.
Transactions, LLC provides financial statement and accounting support for businesses in Mount Airy and surrounding Northwest North Carolina communities.
Understanding your financial statements can help you become a more informed business owner.