Who keeps a record of your business amounts? Have you hired any bookkeeper or accountant? If no then take charge of making decisions about your business, then you require to understand the basics of accounting and 3 financial reports. Plus what every of the financial reporting statements you get as a small business owner intends. In other words, even if you let someone else hold the books for you, you need to know the meaning behind the math.
There are 3 important reports in bookkeeping which you need to take care that’s are of Balance Sheet, Cash Flow Statement, and Profit & Loss Statement. In this article, we will discuss 3 of them in detail.
The important thing in accounting and bookkeeping is to not let the terms and formatting of the financial information scare you. All you require to remember is that you require 3 basic financial statements to maintain track of your money:
- The balance sheet gives your business at a critical point in time and describes the assets you have and who owns them. Information on cash and incomes involved in the balance sheet is formed from the other two statements.
- The cash flow statement shows cash coming in and going out and what the net result is over some time.
- The profit & loss statement will describe all the gains you made and losses in a year.
1) The Balance Sheet
The Balance Sheet shows you the total assets your company owns, liabilities that need to be paid, and the equity that is left with your company. It can be prepared on a monthly, quarterly, and yearly basis. Maintaining a proper balance sheet will help you know the true position of your business and which areas you need more improvements.
Also related to the statement of financial position, a company’s balance sheet gives information on what the company is deserving from a book value perspective.
To maintain a balance sheet, you need to follow certain rules. On the Balance sheet, the Assets will be shown on the right side while the liabilities have to be kept on the left. After properly recording every single transaction on the daily basis, the accountant will deduct all the liabilities with assets which will tell you the exact financial position of the company or where the company stands in the market.
BALANCE SHEET = ASSETS- LIABILITIES
The balance sheet is divided into three sections and provides summations of the company’s :
3) Shareholders’ equity on a specific date.
Assets are the things that your company owns. Examples of assets are furniture, equipment, machinery, etc. These assets belong to your company and you have all the control over them. However, the value of the assets keeps on depreciating along with the time and you need to maintain the records accordingly.
As the name suggests, Liabilities are the debts that your company needs to pay to a third party. The Bank Loan shown in the balance sheet is the best example of the liabilities. Along with this, taxes, mortgage, etc. are other examples of liabilities that are due to the company.
Equity simply means how much you have left in your balance sheet when you deduct liabilities with assets. It also gives you a clear picture of the financial position of the company.
The equity can be calculated as:
Equity = Liabilities – Assets
Usually, a thorough analysis of the balance sheet can give several quick views. For the balance sheet to ‘balance,’ assets need to equal liabilities plus equity. Analysts view the assets minus liabilities as of the book value or equity of the firm. In some cases, a bookkeeper may also look at the total capital of the company. So, it further examines liabilities and equity together. In the asset part of the balance sheet, analysts will typically be looking at long-term assets and how effectively a company operates its receivables in the short-term.
There are a variety of ratios examiners use to assess the efficiency of a company’s balance sheet. Some of the most common involve asset turnover, the quick ratio, receivables turnover, days to sales, debt to assets, and equity debt.
2) Cash Flow Statements
A cash flow statement is a financial record that shows income really received and expenses truly paid. This statement (usually modified for a small business) usually shows opening cash balances, cash inflows, cash outflows, and ending cash balances. In its easiest form, a cash flow statement is shown in the following format:
- Starting cash balance
- Plus cash inflows
- Minus cash outflows
- Equals closing cash balance
It is another great method to know the financial position of your company. As the name suggests, Cash Flow Statements gives you all the information related to cash. It will help you know how much cash is coming or going from your company. This also informs you about how much money you’re spending on a particular thing. The cash flow statements formulas are :
- Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure
- Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital
- Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash
Cash Flow Statements perfectly handles all the money-related transactions.
- Determines the gains and drops in cash
- Formulated over some time, an accounting period (i.e., 1 year, 1 quarter, Year-to-Date, etc.)
- Undoes all accounting principles to exhibit pure cash movements
- Has 3 sections: cash from operations, cash used in investing, and cash from financing
- Displays the net difference in the cash balance from start to close of the period
The section in cash flow statements
There are 3 sections in the cash flow statements :
- a) Operating Activities: The main revenue-generating activities of a business and other activities that are not investing or financing. Any cash flows from present assets and present liabilities
- b) Investing Activities: Any cash flows from the purchase and disposal of long-term assets and other investments not involved in cash equivalents
- c) Financing Activities: Any cash flows that appear in variations in the size and structure of the contributed equity capital or borrowings of the entity (i.e., bonds, stock, dividends).
3) Profit & Loss Statement/ Income statement
It is worth knowing for a business that how much profit they’re earning or whether they’re bearing the heavy loss. Here come the Profit & Loss Statements which exactly gives you information about the profit and loss. With the help of this statement, you can also know about the areas which need to be improved and how you can make your financial position stronger than the previous year.
The profit & loss (P&L) statement shows your revenue, costs, and expenses in a year. The P&L is the best view into your bottom line, or net income, that is why it’s typically related to show business owner and investors whether your company has gained or lost money during a given period.
Your business’s net income is including what is going to use in defining its taxable income every year. This is determined by deducting your business’s expenses from its total revenue, which you can find using your P&L.
If you are well-known with the variations between cash and accrual accounting, you can guess that the way you chose can deliver the figures listed on your P&L. Because every method has its timing for identifying revenue (cash needs money to exchange hands and accrual verifies income and expense as they are received in real-time), the P&L for any provided period will show many transactions or values.
Revenues – Expenses = Profit
How these 3 statements used in financial modeling?
As described above, all of the three financial statements have an exchange of information. Financial models use the aims in the relationship of information within these statements. Also, the aim within periods in historical data to forecast future performance.
The building and display of this information can become very complicated. In common, though, the following steps are must follow to create a financial model.
- Line-items for all of the core statements is set up. This gives the full format and design that the financial model will follow.
- Actual numbers are located in all of the line-items.
- At this point, the bookkeeper of the model will regularly review to make sure that each of the core statements reconciles with data in the other. For instance, the closing balance of cash added in the cash flow statement need to meet the cash account in the balance sheet.
- A premises section is provided within the sheet to examine the trend in all line-item of the core statements within periods.
- Assumptions from existing historical data are only applicable to generate forecasted assumptions for the same line items.
- The forecasted part of each core statement will do the forecasted assumptions to populate costs for each line item. Since the bookkeeper or user has examined past trends in building the forecasted assumptions, the populated values must follow historical trends.
- Maintaining schedules apply to determine more complex line items.
Not maintaining or poorly maintaining financial statements can lead to greater risk for your business. It can further cause great financial loss to your business. So, it is best to hire a professional that can effortlessly maintain all your daily cash transactions and keep your financial statements in check.
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