When it comes to financial information, many small businesses keep to the basic quarterly or annual statements from their accountants. Aside from dealing with the daily financial and cash flow issues, owners can make the mistake of neglecting valuable information—information that can be used to manage their businesses successfully now and optimise its health in the future.
To truly understand the current state of your business and to plan for the future, you need to understand your financial statements. Financial statements assist you to:
- Identify pitfalls and negative trends (too much or too little inventory, costly distribution or a back-log of unpaid accounts receivable) in your operations early on so that you can avoid a disaster later
- Keep an eye on your cash flow requirements and determine any financing needs early
- Monitor your business’s financial health on a regular basis
- Observe periodic fluctuations in wealth
- Check your actual performance against your financial plan
To fully understand the current financial state of your business, you need to understand four basic types of financial statements and what kind of information each one gives you. These are:
The Income Statement
This can also be referred to as the profit and loss statement, it is a report of earnings or a statement of incomes and losses. This statement tells you what income was earned, costs and expenses incurred and net profit during the defined accounting period.
The Balance Sheet
Here you will find a company’s assets, liabilities and owner equity. The balance sheet can be used as a statement of a company’s relative wealth or financial position.
The Position Statement
This explains how a company spent and earned money. This statement may also be referred to as “sources and uses of cash statement” or the “statement of changes in financial position”.
The Statement of Changes in Owner’s Equity
This is used to clarify any discrepancies or changes in the amount of owner’s equity from the beginning to end of a designated period.
Your financial statements are just the beginning of your financial analysis. They do provide important information but you are likely to have to dig a little deeper than just the numbers. For example, you may notice a large increase in expenses one month and upon further investigation, you learn that the expenses were for inventory in preparation for your largest buying season.
The important thing is to use your financial statements as detectors.
When used properly they will set off early warnings of impending dangers.