Businesses of any size all run on the same core concept: the more money in, the faster the company can grow. But how does a business owner actually know how well their company is doing? They know it’s thanks to three fundamental financial statements: the balance sheet, income statement, and cashflow statement.
In this article, we’ll give you a quick runover for each statement so that you can understand why it’s essential, how it works, and what data it shows. Then, once you’re ready for a deeper dive into the core concepts in accounting, we’ll show you where to go next.
Why Are These Statements Important?
Having these three statements up-to-date with the most relevant information is critical for businesses of any size. While they all have their place in accounting, their best use is when all three are put together.
When combined, the business owners and accountants have a comprehensive view of the company’s financials. They can then begin creating projections toward growth if the statements show good numbers or start cost-cutting measures to keep the company afloat if the statements are negative.
A successful company will have an overall positive report, especially if the management handles asset management and debt payment responsibly. A negative report from any of the three statements isn’t a death sentence, though, especially if the company is in a period of growth. That said, having repeated negative reports may mean it’s time for a serious examination into the competency of management. In a public company, this could call for the firing of Board members or demands to sell to a competitor from shareholders.
The Balance Sheet
Balance sheets give a quick snapshot of the company’s overall finances. These are typically pulled for certain time periods and will provide insight into how the company’s assets balance against liabilities and shareholder equity.
Since the balance sheet is for only a specific moment in time, it cannot give a broad-spectrum understanding of all the financials or the company’s overall financial health. Balance sheets are usually pulled to be compared to previous balance sheets or the market share compared to their competitors.
The Income Statement
Income statements give a broader overview of how smoothly the company’s financials are looking. It measures revenue against three types of expenses:
- Direct – All costs of goods sold like materials, labor, etc.
- Indirect – The costs that aren’t directly associated with selling, but are still essential to the daily operations. Examples include salaries, administrative expenses, research and development, depreciation
- Capital – Interest accrued, taxes owed and paid
Once the revenue has these expenses subtracted, the income statement will show the Net Income. In addition, savvy analysts will use the income statement to understand how effective its executive team is, how well the company is stacking up to its competitors, and what departments may be underperforming.
The Cashflow Statement
Cashflow statements are used to understand the amount of liquid capital a company has. The statement shows all revenue streams for a business as well as the costs. Cashflow statements are never for gross sales but are created to understand the company’s overall net profits.
Cashflow statements focus on three areas:
- Operations – Both incoming and outgoing cashflow as part of the company’s operations. The Operations section includes costs like rent, utilities, salaries, and any other required cost to make a sale.
- Investing – The investing section focuses solely on the company’s assets, including asset purchases (like acquisitions) and net gains from the assets (appreciation, interest, etc.)
- Financial – The financial section shows the debts accrued as part of doing business, including issuing stock, dividends, and capital structuring financing.
Through a cashflow statement, the business owners and Board get a comprehensive overview as to the financial health of the company and how well it’s able to pay its debts. Cashflow statements are also helpful for projecting growth or helping prepare the company for upcoming times of low revenue based on past statements (like if a company relies on seasonal selling).
Ready to Learn More?
If you’re ready to get a well-rounded understanding of business financials, we recommend taking our Financial Accounting Professional Certification. This course is designed for entry-level financial professionals looking to better understand the core accounting principles like these three statements and the regulations around them.
Jan 2018, Financial Modeling
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