A Brief Guide About Financial Statements For Your Small Business

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What you will learn?

What are financial statements?

Why are financial statements important?

Contents of a Balance Sheet

Contents of an Income Statement

The Role of Accounting Software in creating financial statements

What are financial statements

Hearing the term “Financial statement” can sound daunting to a person completely unfamiliar with the discipline of accounting. However, like most accounting terminology, financial statements only sound complicated. With a little understanding of basic accounting, a layman can easily understand and interpret a financial statement.

Financial statement is simply information about all financial activities of a business. If an invoice encompasses all information about a product sold, a financial statement like a balance sheet encompasses information about all products sold and bought by the business.

We shall discuss balance sheets later in detail, but it is important to note how financial statements present a broad picture of business activities.

Why are financial statements important

By presenting a broad picture of business activities, financial statements help analyze business performance and progress in the long-term. It is difficult to determine how your business is performing through day-to-day statistics. Financial statements accumulate day-to-day statistics to determine business direction and help you make calculated decisions.

Financial statements are either historical in nature or project future performance based on the past.  The former allow you to seek improvements and incorporate changes based on past performance. They also help understand the financial functioning of a business.

The latter use past data to predict performance in the future, allowing you to set expectations. Apart from guiding your own business decisions, these expectations are also for the eyes of potential investors.

For your small business, two financial statements are of prime importance: balance sheets and income statements.

Balance Sheet

A balance sheet is a financial snapshot of what your business owes and owns within a specific period of time. For example, the balance sheet above is a cumulative total of all deposits and withdrawals since the day business began till the 1st of February 2020.

Informing a great deal about the financial health of a business, a balance sheet attracts most interest from a lender than any other financial statement.

Contents of a Balance Sheet

A balance sheet has two main components: assets and liabilities.Assets are things of value you own, and liabilities are things of value you owe.

There are two types of assets: fixed and current. Fixed assets are long-term assets not expected to be converted into cash within one year e.g. vehicles, property etc. Current assets are cash or assets that can be converted into cash within one year e.g. accounts receivables, inventory.

There are also two types of liabilities: current and long-term. Long-term liabilities are ones that have to be paid in a year or more e.g. real estate loans, equipment loans. Current liabilities is money owed that has to be paid within one year e.g. accounts payables, credit lines.

The difference between assets and liabilities is equity. It is the net worth of a company. The most important thing to remember is that a balance sheet must balance according to this formula:

Assets = Liabilities + equity

This means total assets must equal net assets in the picture above.

Income Statement

An income statement is also known as P&L statement (Profit and loss). It measures a business’s financial performance over a period of time e.g. quarterly, monthly, etc.

The indicator of performance is net profit or loss after all expenses have been deducted. The income statement attracts most interest from the business owner.

Contents of an Income Statement

Total turnover/sales

Revenue generated from business activity

Cost of Sales

Costs incurred to have items available for sale.

Gross profit

Sales- Cost of sales (For example: $500(sales) – $200 (cost) = $300 (gross profit)

Operating Expenses

Cost of conducting business activities. E.g. transportation.

Net Profit

Sales – (Cost of Sales + Expenses

Role of an accounting software

The usefulness of financial statements depends on accurately tracking financial transactions over a long period of time. Accounting software helps you do just that.

  • Trial balance
  • Profit and loss (Income Statement)
  • Balance Sheet

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