Understanding Common Business Financial Statements
Improve your ability to understand and interpret the most common business financial statements needed to run your organization.
Financial Literacy is Essential for Running a Thriving Business
PreferredCFO.com cites several business finance challenges being at the heart of why young businesses failed, with financial literacy coming in on the top of the list:
- 82% – Didn’t understand cash flow or had poor cash flow management skills
- 79% – Didn’t have adequate working capital at the outset
- 78% – Didn’t have an effective or well-developed business plan
- 77% – Didn’t price products or services properly
- 73% – Didn’t predict sales or costs accurately
- 70% – Didn’t know what to do to succeed and failed to seek help from those who did
It’s nearly impossible to overstate the importance of financial literacy. While a business owner can learn along the way, having a strong understanding of the financial needs and performance of their company can help them avoid making some of the costly mistakes that can hurt an organization.
This need only grows over time, from knowing how much money you need to start up, to understanding when it’s time to make changes in your business. Paying close attention to the common business financial statements produced each month, quarter or year can give you invaluable insights into sales trends, vendor costs, payroll and other business expenses so that you can take action before a small problem escalates.
Overview of Common Business Financial Statements
What is a Balance Sheet?
The balance sheet shows an organization’s assets, liabilities and net worth. The organization’s assets must be equal to the sum of its liabilities (debts) plus equity in order to balance.
Assets are items an organization owns that have value; meaning, they can be sold or leveraged to make services or products which can be sold.
Liabilities are debts owed by the business to another organization or individual.
Net worth, or equity, is what an organization would have if all assets were sold and all liabilities satisfied. An organization’s net worth belongs to its owner and/or any and all shareholders.
What is an Income Statement?
The income statement shows how much revenue, or income, an organization earned over a specific time period (often over a quarter or year). And it also shows the costs and expenses attributed to earning that revenue.
The commonly used phrase, “the bottom line…” is derived from the actual bottom line of the income statement because it shows an organization’s net income or net loss after costs and expenses are deducted.
What is a Cash Flow Statement?
While income statements have a bottom line of net earnings or loss for a given period, cash flow statements show the movement of cash in and out of an organization.
Understanding the flow of cash going in and out of your business is important because you need to know whether you have enough money coming in to cover operating and capital expenses. It can also help show you where your cash is coming from (or whether activities, such as operating activities) are not generating enough cash to cover operating expenses.
So what if you do have slow cash flow? Apart from growing your business or increasing sales, another way to speed up cash flow is to factor customer invoices instead of chasing down payments. Some companies do this on an on-going basis until they have grown to the point that incoming revenue from sales more than cover business expenses. Other companies choose to factor invoices only occasionally or to spot-factor invoices in order to free up working capital to meet payroll, invest in emerging growth opportunities, pay vendors more quickly for fast-pay discounts, and so on.
The more you understand your organization’s cash flow, the better you can leverage financial tools that expedite working capital. This can help you run your business more effectively and efficiently, or put you in a position to grow your company faster.
Why Understanding Common Business Financial Statements is Important
In business, chances are that sooner or later you will need to be able to read and interpret common financial statements in order to make good business decisions for your organization and avoid costly mistakes.
A better understanding of the financial position of your business can help you determine whether, and how, business financing options like invoice factoring could provide you with expedited working capital or a more consistent flow of cash so that you can focus on growing your business to the next level.
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