Finances are the life source of business so it should come as no surprise that preparing financial statements is one of the most important tasks. While there might be a lot of different financial statements available, there are only three that every business must have:
- Income Statements
- Cash Flow Statements
- Balance Sheets
Financial statements are important for a number of reasons. Firstly, they allow you to keep track of important information about your business. Second, they are used by investors to help decide whether or not to invest in your business. Finally, financial statements help you determine accurate prices for your products and services.
An income statement (also called a Profit and Loss Statement) shows the performance of a business within a specific period of time. Depending on the business, this report could be run monthly, quarterly, or yearly. Most businesses have all three types of income statements. Data within this statement lists a summary of revenues and expenses that a business incurs during the specified timeframe.
Revenues – Expenses = Net Income
In layman’s terms, an income statement shows the overall profit or loss a business incurred during the month, quarter, or fiscal year. How much money did the business make?
The reason this statement is important should be obvious, but I’ll say it anyway. If your business isn’t earning money, they why are you in business, to begin with? Income statements also help a business convince investors to put money into the business.
Cash Flow Statement
A cash flow statement shows the movement (or flow) of money within a company. It reveals what goes into the business and what flows out. There are three types of activities on every cash flow statement:
- Operating Flow
Cash flow can be seen as the blood of a business. It must constantly be flowing, otherwise, the business will die. Therefore, entrepreneurs must know where their money is going. If they don’t, then the business will eventually run out of cash.
Cash flow statements track two processes – inflow and outflow. What goes out must come back into the business. This is the cycle that keeps a business sustainable. Outflow is comprised of expenses while inflow is money received through sales and investments.
Balance + Inflow – Outflow = Cash Flow
If cash flow is negative, then a business must make some adjustments in order to put it back in the green. Otherwise, the business will eventually run out of money.
Finally, we’ll discuss a balance sheet, which is used to track the financial position of a business. It shows how much your business is worth during a specific period of time.
A business’s balance sheet is considered to be the most important of all three financial statements since it shows the overall value of your business. This statement outlines all debts, equity and profits of the business to provide a snapshot. This snapshot reveals the overall health of the business as a whole. Since everything is factored in, the balance sheet will show you whether your business is thriving or failing.
For example, if your business has more debt than assets, this snapshot will show you that your financial management is struggling.
If you’re looking to apply for loans or sell your business, then your balance sheet is the single most important report that you have at your disposal.
The bottom line is that your business must be able to pay for its assets. A balance sheet shows whether or not it’s doing that.
Assets = Liabilities + Owner’s Equity