Financial Statements are important because to understand finance it is vital to have understanding of the three most important financial statements, Balance sheet, Income statement and Cash flow statement.
Balance sheet shows company's financial position at a particular point in time. The financial position is described using three parameters, Assets, liabilities and shareholder's equity.
This statement shows what you own (assets), what you owe (liabilities), and what’s left over (net value or equity in the business). The numbers change every time you receive money or give credit to a client as well as when you pay for or charge an expense.
Liabilities + Net Worth = Assets
Think of the Balance Sheet like a scale. Assets and liabilities alone are out of balance until you add capital, the last weight put on the scale, to makes it balance.
Assets are divided into two categories: current and non-current. They are listed according to how liquid they are (how quickly they can be turned into cash). Examples of current assets are cash and inventory. Examples of non-current assets are furniture, fixtures, property and equipment. Money owed to your company (accounts receivable) is considered an asset.
Liabilities (debts you owe) are divided into two categories: current and non-current (or long-term). They are listed in the order they need to be repaid.
Capital or Net Worth
The business’ equity includes money the owners have invested and income kept in the business from the company’s profits
Balance Sheet Shows
- How much of your loan debt is current, and how much is long-term
- The net value of the business
- Percentages and ratios (which are extracted from the numbers) necessary to analyze your business
- Compare two of the same time periods to see changes in: cash, accounts payable, accounts receivable, equity, inventory, retained earnings, etc.
Balance Sheet Won't Show
- Income or expenses over a period of time. Remember, the Balance Sheet reflects one moment in time
- Market value of assets, although it will reflect purchase costs and depreciation according to industry standards
- Quality of assets
- Contingent Liabilities (money you agreed to repay by signing notes, or by being a comaker or guarantor of loans)
|Balance Sheet||Dec 31 2014||Dec 31 2015|
|Total Current Assets||753,000||547,000|
|Property, Plant, and Equipment, net||877,000||853,000|
|Total Liabilities & Equity||$1,630,000||$1,400,000|
Think of the Income Statement as a report card for your business. It is issued from time to time and gives an overview of how you are doing.
In the day-to-day running of your business, numbers fly around at a dizzying pace. Bills are paid, money is taken in, and sometimes, in this whirlwind of activity, it’s hard to know how much you’re actually making. The Income Statement answers that question. Think of the Income Statement as a kind of report card for your business. Like a report card, it is issued from time to time and gives an overview of how you are doing (for that period of time). Since this statement reflects your business activity over time (not like the Balance Sheet which is a snapshot of your business for one moment in time), it is usually developed monthly, quarterly and annually. Creating a projected statement for the next 12 months, based on your predictions, is also a good idea.
What Income Statement Shows
- If sales are going up or down
- Your gross profit — how much money is left for the rest of the business after deducting what it costs to produce or purchase the product
- All expenses for the time period it covers
- Increases and decreases in net income
- How much money is left to grow the business
- How much money is left for the owner(s)
- How much money is left to pay debt (principal only)
What Income Statement Won't Show
- If your overall financial condition is weak or strong
- What’s tied up in Accounts Receivable (money owed to you) and Accounts Payable (money you owe)
- What you own (assets) and what you owe(liabilities)
|Cost of Goods Sold||800,000||725,000|
Cash Flow Statement
What money comes in, what goes out, and what stays.
Cash is the fuel that runs your business. Running out of it would be disastrous, so you must have a “cash flow” or money on hand to pay bills and meet day-to-day expenses. Keep in mind that companies can produce a profit, but still not have a positive cash flow. The Cash Flow Statement shows money that comes into the business, money that goes out and money that is kept on hand to meet daily expenses and emergencies.
What Cash Flow Statement Shows
- If the business has enough money to: - cover day-to-day activities - pay debts on time - maintain and grow the business without a negative cash flow
- The need for additional working capital (cash) when sales increase since increased sales mean increased purchases of material or labor. You should know how much you need. Show where the additional working capital will come from.
- The maximum loan payment the business can afford
- The breakdown of principal and interest on your loan payments. Note that the Income Statement only shows interest - not principal.
- ■ Your weaknesses (an inability to keep and generate cash). For lending purposes, explain how you’ll handle these weaknesses (via increased sales, cost reductions, or owner’s investments).
What Cash Flow Statement Won't Show
- How much you have in Accounts Receivable and Accounts Payable (shown in the Balance Sheet)
- Your balances in assets, liabilities and net worth
- Depreciation of equipment, which is a non-cash expense. This is dealt with in the Balance Sheet.
|Cash Flow Statement|
|Cash Flow from Operating Activities:|
|Cash received from customers||146000|
|Cash paid for expenses||81000|
|Cash paid to suppliers||47500|
|Cash Flow from Investing Activities:|
|Cash paid to acquire additional equipment||20300|
|Cash Flow from Financing Activities:|
|Cash received from investment of owner||10000|
|Cash received from bank loan||50000|
|Cash paid for bank loan – partial payment||27000|
|Cash paid to owner – withdrawal||20000|
|Net Increase (Decrease) in Cash for the Year||10200|
|Retained Earnings from last year||10800|