Financial statements are useful tools that will help you keep your business on track. There are many different types of financial statements, but most small business owners need only worry about the big three.
The “Big Three” Financial Statements
The big three financial statements include the income statement (P&L), balance sheet & statement of cash flows.
- The income statement provides a breakdown of revenues and expenses in a business, providing critical insight into profitability over a defined period of time. The income statement is a complete representation of the company’s activity for the defined time period. This statement is considered temporary as it “resets” to zero at the beginning of the new period (typically monthly).
- The balance sheet provides a snapshot of your business’ assets, liabilities and owner’s equity giving you an instant picture of your company’s financial underpinnings at a particular point in time. The balance sheet shows a culmination of historical activity through the company’s lifetime, essentially showing what you’ve done to date. At the end of the month, the income statement activity will be reflected on the balance sheet as increases or decreases to the account balances.
- The statement of cash flows gives you the ability to see all the cash going in and out of your business. It is a representation of how changes to accounts affect cash and equivalents. This statement is broken down between operating, investing and financing activities, giving you a more accurate picture of where cash is flowing.
Balance Sheet vs. Income Statement
While the cash flow statement deals only with cash you have on-hand, the income statement and balance sheet focus on money that you have recognized in your business, which doesn’t necessarily line up with cash coming in or leaving your business.
The key to telling these two apart? Time. The income statement shows revenue and expenses over a defined period of time, like a month, quarter, or year. The balance sheet is a snapshot of your business—what it owns outright and what it owes to others—on a single day in time. Think of the balance sheet like the cumulative effect of all your past income statements.
To learn more about the fundamental differences between the balance sheet versus the income statement, check out this article for more details.
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Still not convinced you need financial statements? Here are three reasons why they’re an absolute must:
1. Financial Statements Are Useful Tools
Financial statements are the most useful tools you can use to understand the current and future financial health of your business. When prepared correctly and reviewed regularly, the big three financial statements provide a complete picture of your business’ finances. Financial statements can seem overwhelming at first glance, but they’re actually pretty simple.
2. Financial Statements Are Scorecards
Financial statements are like a scorecard you can use to measure your business’ performance. By using financial statements, you can determine where your business is underperforming and where it is excelling. You can also compare it to industry standards, giving you a good idea of where you stand against your competitors.
3. Investors and Banks Expect Financial Statements
Financial statements are Business 101! They are expected by investors and required by banks because financial statements tell the complete story about your business. If you want to get a loan, keep in mind that many banks or lenders will not consider a loan application without current financial statements. If you’re serious about attracting investment, financial statements are a must. Investors need proof that you’re business is worth investing in before they give you a check. Many investors find it unprofessional and are typically unsympathetic to companies who don’t handle their finances properly!
The Bottom Line
Financial statements are too important to ignore. While they may seem complicated and intimidating, financial statements actually pretty easy to understand. If you want to achieve success in your business, attract investment or get a bank loan, you must use and review your financial statements regularly.