By Bryce Welker, a CPA and CEO of multiple companies, including Accounting Institute of Successful CPAs.
Income statements, balance sheets and cash flow statements. If you run a business, you probably have some knowledge of basic financial statements and how to use them. But do you know why they are essential for entrepreneurs to use as a guide to growth?
If the answer is no, you’re not alone!
So many busy business owners get caught up in the grind and never bother to run reports or analyze much other than the bottom line. If the use of financial statements is not part of the strategy, you are unlikely to become one of the many companies to reach the 10-year mark.
Fortunately, you don’t have to be a guru to understand fundamental financial statements and harness your power as an entrepreneur or executive.
As a CPA and CEO of several companies, I’d like to provide an overview of three main types of financial statements, why they should be important to you, and what you can do with the information on each.
Analyzing income statements
Financial statements are like a snapshot of your company’s overall financial health. They help you determine where you are and plan your next steps. From net worth figures to earnings forecasts, understanding financial statements is vital to gauging your strengths in the market and your weaknesses.
Income statements can be used to identify income and expenses, evaluate profitability, provide information to stakeholders, and plan for the future.
They usually include income, expenses, and gains or losses made over a period of time. Also called profit and loss statements, they show you how much was earned, how much was spent, and where you stand financially.
When viewing an income statement, you will find information associated with assets, liabilities, equity, owner investments, and owner distributions. It also includes income, expenses, gains/losses and total income.
Do you want to borrow money to increase production, launch a new product or market your current services? This critical information can be presented to those interested in your business. Again, income statements will be your best friend as they illustrate your company’s ability to pay off obligations.
Often confused with income statements, balance sheets are reports that show a company’s assets, liabilities and shareholders’ equity at a point in time. Balance sheets can be used to monitor financial health over time, make debt and investment decisions, and attract new investors and talent.
When you look at a company’s balance sheet, you can do a few things with it.
First, you can analyze liquidity and determine whether there are enough short-term assets to cover short-term debt. This is done by comparing the company’s current assets with its current liabilities.
You can also evaluate efficiency by looking at asset turnover rates. In other words, are you using your assets in an efficient way that generates more money? Finally, you can use balance sheets to assess solvency and answer the question, “Do we have enough assets to cover long-term debt?”
All these applications lead to one thing: a better overall picture of a company’s financial health. From there you can make big decisions. For example, because they help pinpoint risk, balance sheets can help you decide whether you can afford to put more money into capital or whether you need to keep more cash on hand. They can also be used to secure private equity financing and prove you can pay back what you want to borrow.
Finally, these financial statements can help you attract and retain new talent. Employees want to know their jobs are safe. After all, not many top executives will want to work for a company that is in debt.
Consider cash flow statements
The third part of the financial statement trio is a cash flow statement. Cash flow statements can be used to track inflows and outflows and find ways to improve a company’s financial position to achieve long-term goals.
Like the other two types, it analyzes this information over a period of time. So consult a cash flow statement if you want to know what you earn and spend.
In predicting possible pitfalls and hitches that may arise in the future, a cash flow statement can also help you with this. Cash flow statements are very good to help entrepreneurs and managers find areas for improvement.
Let’s say you own a taco truck chain and you’re preparing a cash flow statement for the past year. You notice that your company had a negative net cash outflow this year. You know that means you spent more money than you brought in. However, you want to use this information to make decisions about your business going forward.
What can you do?
Well, first you analyze your inflow and outflow. Were your primary sources of cash inflow from customer payments? Did much of your money come from loans? What were your main cash outflows? Did you spend the most on paying your suppliers, employees, or maybe rent?
Once you have this information, you can create a plan to get the business back on track and out of the red.
Financial statements are essential tools for any business owner. They not only give you a comprehensive overview of your company’s financial performance, but also help you make informed decisions for the present and the future.
You can use income and cash flow statements and balance sheets to monitor financial health in a way that is simply not possible otherwise.
Still not sure where to start? One of the best ways to get started is to just dive in. Choose a financial statement to focus on, run the report and start analyzing. If nothing else, you’ll walk away with more knowledge about your business and the best strategies for moving forward.