A Guide to Small Business Financial Statements
Businesses of any size or industry can benefit from generating regular financial statements. Even when starting out, financial statements become a vital business plan component. These reports help you map out your business’s future and gain investors’ confidence. Keep reading to see financial statement examples for the three major reports we’ll cover.
With financial reports on hand, you’ll stay informed on how well you earn money and its flow in and out of your business. This article guides you on how to generate financial reports for better decision-making.
What is a Financial Statement?
Financial statements are a group of formal reports showing a company’s financial results. These results may reflect a given period, as with income and cash flow statements. Or cover a snapshot of a specific moment, as with a balance sheet. Later, we’ll go over financial statement examples to better understand these three key reports.
Companies gauge financial performance using the information shown on the individual statements. The three major ones are the income statement, balance sheet, and cash flow statement. Together, these reports inform you where your financials stand. By analyzing their insights, you can make better decisions towards improving financial performance.
Who Uses Financial Statements?
Many entities find it helpful to analyze an organization’s financial statements. Each will have its own reason for wanting to view a financial statement’s information. Here are the most commons users of financial statements:
Management. Higher-ups need to understand financial health to make better plans and decisions.
Investors & Creditors. Your business must show viability to qualify for investment and credit.
Government. Your jurisdiction needs financial statements to see if you pay proper taxes.
Vendors. Your suppliers may need reports to decide if they want to extend you credit.
Competitors. Those competing against you also want to see how well you do financially so they can improve their own.
Why is a Financial Statement Important?
Analyzing financial statements is essential to ensure profitability and a healthy cash flow. You can track revenue and profits with ease for your small business. Still, there are other KPIs that determine financial performance. Your assets, liabilities, and net cash flow also determine how you do financially.
By generating a complete set of reports, your business gets to enjoy the following benefits:
Look at several financial statement examples back to back, and you can plot trends from individual results. Adhering to regular reporting makes it easier to look at performance over time. All you have to do is compare specific results to the ones before it.
Say that after six consecutive monthly cash flow reports, you spot a downward trend in net cash flow. Now that you’re aware of declining performance, you can dig deeper into the problem.
Track Performance In Real-Time
With financial statements, you can see your performance in real-time. Financial reports might cover specific periods, like a quarter or a year. But, there’s no stopping you from generating reports on the fly. Want to know how well you did in profits compared to expenses this week? Make an income statement just for that period.
Manage Assets & Debts
View the financial statement examples of successful businesses, and you’ll find a healthy debt-to-asset ratio. A company’s amount of debt impacts its financial health. A balance sheet lets you look at assets and liabilities separately to plan strategies for improving both.
Stay On Top of Cash Flow Health
You’ve heard it a lot. Cash flow is the lifeblood of a business. Your financial reports will help ensure that you have enough cash to grow your business. You can immediately gauge your business’s money flow by creating a cash flow report. Cross-reference that with an income statement to see if cash grows alongside profits. We used the financial statement examples below to explain the co-relations between the three major financial reports.
Step-By-Step Financial Reporting Using Financial Statement Examples
Putting together a financial report begins with a company’s bookkeeping. Bookkeeping is the practice of tracking and recording a company’s day-to-day transactions. Companies later summarize these records into helpful financial statements.
Financial reports can be tedious to compile, but you can speed up the process with software. Many accounting tools feature reporting functions to help businesses generate accurate reports fast.
There are three main financial statements that you need for financial reporting: the income statement, the balance sheet, and the statement of cash flows. Each of these statements provides important information about your company’s financial health and performance.
1. Income Statement
An income statement, also known as a profit and loss statement, is a financial statement that shows a company’s revenues and expenses over a period of time. The purpose of the statement is to show whether the company is making a profit or a loss. The statement can be prepared for any period of time, but is typically prepared on a quarterly or annual basis.
Generating this report lets you know how profitable you are during a given period. It shows how much you earned (revenue) and how much you spent (expenses). We’ll drive home the point using financial statement examples:
Revenue, the top-line item, is where you’ll deduct every expense. After subtracting the costs, you’ll arrive at net earnings during your chosen period. In this example, our selected period is one year, from January 1st to December 31st, 2022.
Steps to Preparing an Income Statement
Generate A Trial Balance
Trial balance reports show the end balance of each account in the general ledger. You can generate this report fast if you’re using accounting software.
Lump Up Revenue During The Period
Calculate the total amount of all revenue entries on the trial balance. Remember that revenues include those sales you made on credit.
Get The Cost Of Goods Sold (COGS)
COGS are the direct cost of producing your goods or services. Examples of COGS are raw materials and the labor it took for those raw materials to become the end product. In the example, you can see COGS below revenue.
Calculate the Gross Profit
Subtract COGS from revenue to get the gross profit for the period. This line item shows your earnings after considering the direct cost of revenue.
Include Operating Expenses During the Period
Include the total amount of every operating expense item on your trial balance. Operating expenses include General & Administrative, Marketing, and R&D if you have one.
Calculate Pre-Tax Income and Income Tax
Subtract the total expenses from the gross profit to arrive at earnings before tax. Next, you need to calculate how much tax to pay. Your income tax rate is a percentage of pre-tax income.
Calculate Net Earnings
Your net earnings or income is your company’s profit during the period. Calculate it by subtracting the income tax from pre-tax income.
Complete the Report
Make sure to identify your document by placing “Income Statement” as a header. Place it right below your business name and the period you’re covering.
2. Balance Sheet
Unlike an income statement, a balance sheet is a snapshot in time. It covers your financial situation here and now rather than during a specific time range. You’ll find your company’s assets, liabilities, and owner’s equity on the balance sheet. As an accounting rule, assets must always be equal to liabilities plus equity.
Not sure what a balance sheet looks like?. Let’s dive deeper into it with financial statement examples:
You may notice that our example displays five consecutive years. As with every other financial statement, comparisons allow you to gauge performance. This way, you can bolster your financial planning for the best results.
Steps to Preparing a Balance Sheet
Choose A Regular Date
How often you create balance sheets depends on your business. Some businesses do it weekly or monthly to compare results on trends. A common practice is to prepare them on the last day of every quarter.
List All Your Assets
The next step is to list all your existing asset types in separate line items. Arrange assets based on liquidity, starting with the current assets. Current assets include cash, accounts receivable, or anything you consume within a year. After listing the more liquid ones, continue with the non-current or long-term assets. These assets go last since they’re less liquid, and you can’t convert them to cash within one year.
Calculate Total Assets
Simply add every asset line item to arrive at your present total assets. Now you’re done with the left-side part of the balance sheet equation. Remember that this must equal liabilities plus equity on the other side.
List All Your Liabilities
Include every other liability account from your company’s ledger. Separate current from long-term liabilities. Current liabilities are debt your company pays within one year. Accounts payable and any short-term debt belong to this category. Long-term liabilities consist of long-term obligations not due within the current year.
Calculate Total Liabilities
Now that you have all liability accounts lined up, it’s time to grab the total. Your total liability is the combined obligations your company owes at the moment.
Calculate Owner’s Equity
The owner’s equity is the last part of the balance sheet equation. Retained earnings, total shareholder equity, and working capital make up the owner’s equity. Gather these data and calculate the total.
See if The Equation Balances
After totaling the three variables, see if they match using the equation:
Assets = Liabilities + Owner’s Equity
If you see an imbalance between the two sides of the equation, go back and see what you’ve missed.
3. Cash Flow Statement
You’ve got revenue & profits figured out with your income statement. It’s also crystal-clear what you own and owes with your balance sheet. Now, you want to understand your cash’s movement in and out of the company. For that, you’ll need a cash flow statement. Like an income statement, a cash flow statement covers a specified period.
As with our financial statement examples, a cash flow statement has three parts: cash flow from operations, investments, and financing activities. There are also two methods of writing a cash flow statement: direct and indirect. The indirect method is the most commonly used by businesses, and it’s the one we’re going to cover in this guide. You can see that the cash flow statements above are lined up to give a preview of performance year-over-year.
Steps to Preparing a Cash Flow Statement
List Net Income From the Income Statement
Remember the net income from your income statement? That’s going to be the top-line item for this report. List your net income from the same period you cover in your cash flow statement.
Add Back Non-Cash Expenses
When arriving at net income, your calculation doesn’t always constitute actual cash transactions. For example, you write off depreciation as an expense without spending real money. Add back every non-cash expense on the cash flow statement. Other non-cash items include amortization and accounts payables. You’ll also need to add any positive non-cash changes in your balance sheet’s assets and liabilities.
Subtract Non-Cash Gains
Accounts receivables are recognized as part of revenue, even if you haven’t collected actual money. So, you’ll need to subtract it from net income to ensure a cash basis figure. Along with that, remove the effects of any non-cash gains from the balance sheet.
Determine Net Cash Flow from Operating Activities
After adding and subtracting non-cash items from net income, you arrive at your net operating cash flow. This reflects your cash flow from conducting core business activities.
Add Changes From Investing Activities
Investing cash flow is the next section of your cash flow statement. Its entries include gains or losses from security investments and long-term assets. In our example, capital expenditures (spendings on long-term assets) account for our net investing cash flow.
Add Changes From Financing Activities
The third is cash flow from financing activities. Here, you’ll need to add or subtract all the cash transactions the company has made to finance itself. These activities include receiving money from stock issues and paying dividends to shareholders.
Calculate Total Net Cash Flow
Add the cash flows from operating, investing, and financing activities to get your total cash flow. Your result can either be an increase or a decrease in cash.
Determine the Cash Balance At the End Of the Period
In the last section, list the opening cash balance. It’s the amount of available cash at the beginning of a period. Next, adjust it with the resulting total cash flow. This result could be an increase or a decrease. The back-to-back cash flow financial statement examples above show a three-year decrease followed by a three-year increase in net cash flow.
Make Your Life Easier with Software
If you use accounting software like Xero or QuickBooks, you’ll have little trouble generating financial statements. These programs can do it for you based on your records. Accounting software is efficient in its own rights. But if you want to focus on pure cash management, connect a tool like Peakflo.
Handle your cash management and AR collection like a pro with Peakflo’s cash flow-focused advanced reporting, forecasting, and automation.