Why are financial statements important?

Your financial statements tell a story of how your business performed in the past, how it’s performing now, and even how it may perform in the future, based on projections. With this information, you may make more informed business decisions and prove to lenders and investors that your business is expected to succeed. Ask yourself:

Past

• Is my business competitive?
• Is my business on a growth trajectory?
• Have I been building equity?

Present

• Where should I be spending my time, personnel and funds right now?
• Am I on track to reach my goals?
• What are my current fiscal priorities?
• How much cash do I have?
• Should I consider getting credit to cover businesses expenses?

Future

• Will my business continue to grow if operations stay the same?
• Are there patterns or trends in my business that could hinder or help me as I move forward?
• Do I have enough capital to cover upcoming expenses?
• Who cares about my financial statements?

You probably won’t be the only one looking at your business’ financial statements. Most companies and organizations that you borrow money from or enter financial arrangements with will ask to see your statements.

• Government: Your income statement, and sometimes balance sheet, will be needed to complete your taxes, even if you don’t earn a profit. Plus, maintaining sound business records will save you a lot of trouble if your business is ever audited.
• Financial institutions: Lenders will want a copy of your accounting statements when reviewing a loan application. Financial institutions are far more likely to lend to financially healthy businesses with leaders who understand accounting best practices.
• Investors: Investors will want to review your financial statements as part of the due diligence process. Having accurate financial statements may reduce the doubt that an investor has about investing in your company.

Most common financial statements

• Income statement: The income statement reveals how a company is earning and spending money over a specific period of time. It provides information about how much it costs to create your product or service.
• Balance sheet: The balance sheet provides a snapshot of how your business is performing at a single moment of time by showing the breakdown of assets, liabilities, and owner’s equity.
• Statement of cash flows: The statement of cash flow shows the net change in the balance of cash from one period to the next. It’s a good way to show the inflow and outflow of your business’ cash on hand.

How do I use an income statement?

The income statement reveals how your business' sales compare to your total expenses. Your business’ "bottom line," or earnings for that time period, is listed at the bottom of the report under "Net Profit."

An income statement is made up of five parts:

• Overhead: Money used to support your business other than costs of goods sold (e.g. rent, insurance, marketing, salaries).
• Revenue: The amount made from the sale of products or services.
• Net Profit: Earnings after all expenses are deducted.
• Gross Profit: The revenue remaining after deducting cost of goods sold.
• Cost of Goods Sold (COGS): The costs that go into creating and selling a good or service (like inventory, labor, and shipping).

Revenue is sometimes called "top line income" because it's located at the top of the income statement.

How do I use a balance sheet?

Balance sheets show your business’ assets (what your business owns) versus its liabilities (what it owes). The resulting calculation is your business’ equity (essentially, what your business is worth).

It’s called the balance sheet because total assets should be equal to the total liabilities plus equity of a business, resulting in an equation that looks like this:

Assets = Liabilities + Equity

A balance sheet is sometimes known as the "Statement of Financial Position."

How do I use a statement of cash flow?

The cash flow statement shows how cash moves in and out of your business over a specific period. These statements are broken down into the following categories:  

• Operations: The operations portion subtracts net earnings from all cash needed to operate the day-to-day functions of your business.
• Investing: The investing section includes the value of the property and equipment owned by the company. This is the amount that you would expect to receive if you liquidated your assets and can indicate your business’ potential for growth.
• Financing: The financing section lists the amount of cash paid out in equity (dividends, stocks) and for debt repayment. It also shows cash inflow from capital fundraising.

How do all these financial statements work together?

Each of these financial statements fit together to create a detailed picture of your business’ financial health.

The closing cash on hand from the cash flow statement is part of the assets listed on your balance sheet. The operations item found on your cash flow statement is used to calculate net earnings, found on your income statement.

The information in this article was obtained from various sources not associated with Adirondack Bank. While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. Adirondack Bank is not responsible for, and does not endorse or approve, either implicitly or explicitly, the information provided or the content of any third-party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. Adirondack Bank makes no guarantees of results from use of this information.

Article written by EVERFI