Understanding Financial Statements and Ratios
Understanding financial statements and ratios is an essential asset for all business owners. It offers valuable insight into your company’s performance, enabling you to plan ahead for the upcoming fiscal cycle.
Financial ratios are numerical values taken from your company’s financial statements (balance sheet, income statement and cash flow statement). They help assess liquidity, leverage, growth potentials, margins profitability rates of return valuation and more.
Balance Sheet
The Balance Sheet is an accurate representation of a company’s assets, liabilities and owners’ equity at any given moment in time. It follows a formula that calculates assets as the sum of liabilities plus shareholder equity (net assets).
Assets refer to tangible items owned by a company with value, such as cash, equipment and buildings. They may also include intangible assets like patents and trademarks.
Liabilities are the debts a company owes other parties. They appear on a company’s balance sheet according to their due dates, divided into current liabilities and long-term obligations.
Ratios that measure a company’s total assets, liabilities and shareholders’ equity (owners’ equity) are used to help investors determine profitability, liquidity and solvency. While some of these ratios may be complex, others are straightforward and essential for business owners to comprehend.
Income Statement
The Income Statement is the document that most accountants, investors and business owners consult when trying to understand a company’s financial health. It includes gross revenue generated through sales and expenses as well as earnings per share (EPS) declared to its shareholders.
The income statement is essential for tax compliance purposes, as it reveals how much tax the company has paid or will pay in a given year. Furthermore, it gives an overview of how well-run the business has been in relation to its projected outcomes.
The income statement is a key component of financial reporting and can be prepared on either monthly, quarterly or annual bases depending on the company’s requirements. It provides management, investors and shareholders with an accurate overview of a company’s performance over time and paints a vivid picture of its financial prospects.
Statement of Cash Flows
A statement of cash flows is one of the most essential financial documents a business owner should comprehend. It offers detailed insights into cash inflows and outflows that can be used to make informed decisions for the future.
The initial portion of a cash flow statement addresses operating activities. These encompass core business tasks such as sales of goods and services, salary payments, rent payments and income tax deductions.
In addition to these transactions, the statement also includes cash from investing and financing activities. This could include purchases or sales of long-term assets like property, plant, equipment as well as investments in non-physical assets like patents.
Financing activities involve collecting cash from investors or banks, issuing and purchasing shares, and distributing dividends. On the balance sheet of a company or its shareholders, these transactions appear as cash to them as well as an amount owed to creditors.
Statement of Retained Earnings
The Statement of Retained Earnings is a financial document that displays the amount of profits accumulated and held in reserve by a company. This information is crucial for business owners and investors as it provides insight into how a business plans to utilize its profits for future expansion.
Business owners can use data to make more informed decisions about where to invest their earnings. For instance, they may opt to reinvest funds back into the business or pay dividends to shareholders.
Typically, the statement of retained earnings is constructed as an equation that begins with the previous year’s beginning balance and adjusts for net income and dividends. Finally, it ends with a new retained earnings balance for the current accounting period.
A company’s statement of retained earnings is an important document for both business owners and creditors alike. If a company’s retained earnings are low or negative, it could negatively impact its capacity to secure loans and outside investment.
