Financial statements can be daunting for a business owner, especially if you don’t know what they’re telling you. However, having and understanding these documents will give you the insights you need to grow your business. The three main financial documents are the:
Profit and Loss (P&L) or Income Statement
Cash Flow Statement
These three documents help you see where your business stands, where it has been, and where it has potential. Financial statements provide you with information to manage and grow your business and it provides financial institutions, investors, and suppliers the information they need to trust and help your business. The Balance Sheet and P&L will also be used in filing your taxes at year end.
How to Create Your Financial Statements
Financial statements start with your journal entries. Every business transaction needs to be recorded for accurate statements. Journal entries are then transposed onto your general ledger, which shows the total of all your chart of accounts. Totals are separated into two columns, debits and credits.
Information from your general ledger is then used to create your trial balance report. Once you’ve made all your adjusting journal entries, you’ll have an adjusted trial balance which you can use to create your financial statements. This process of turning your journal entries into financial statements is known as the accounting cycle.
Now, let’s take a look at each of these documents and how they can help you.
The balance sheet allows you to assess the current value of your business. It consists of three sections:
Assets: what you own (cash, inventory, property & equipment, real estate, etc.)
Liabilities: what you owe (loans, credit card balances, accounts payable, etc.)
Owner’s Equity: what the company is worth (assets – liabilities)
In the end, Assets = Liabilities + Owner’s Equity. This means that the assets that you’ve acquired will always be equal to the cost of the assets (liabilities) plus the amount of value you or the stockholders have in the company (equity).
While this provides a snapshot of your business at a specific point in time, it is not a good way to assess overall performance. That’s because you need to look at your financials over a given period, which is what the P&L and Cash Flow Statement are for.
Profit and Loss Statement (P&L)
The P&L, also known as the Income Statement, details your revenue and expenses for a given period. It starts with your revenue and subtracts your expenses until reaching the net profit or loss. Since this document gives you a view of your revenue year-over-year or period-over-period, it is a good way to see the profitability of your business.
Cash Flow Statement
This statement will show you the flow of cash going in and out of your business over a given period. Cash flow is divided into three categories:
Cash flow from operations: income and expenses from business activities (sales, wages, rent, etc.)
Cash flow from investing: income and expenses from your company’s investments (equipment, assets, investments, etc.)
Cash flow from financing: income and expenses from investors or banks (loans, etc.)
With the cash flow statement, you can analyze the management of cash in your company and determine whether you have enough coming in to pay off your financial obligations.
And there you have it – a basic overview of three essential financial statements for small business owners. These documents will provide financial insight to assess the performance of your company and help you grow.
As a business owner, it's a good practice to view these statements on a monthly or quarterly basis to get a snapshot of how your business is performing, to check for accuracy in accounting/bookkeeping, and to make future decisions about spending and tax planning. If you aren’t creating and going over these documents periodically, now's the time to start!
If you need assistance, our experienced team at Summit Bookkeeping can help you prepare and go over these important statements! Contact us or give us a call today at 360.756.5020.