Although financial statements are a necessary part of running a successful business, they usually aren’t something business owners look forward to doing. Most owners start their business because they either love business in general or are passionate about a particular field. Financial reporting is a necessary evil that many owners put off until it absolutely has to get done.
When done properly, financial reporting is actually very insightful. Hiding behind all those numbers, figures and formulas are the keys to analyzing the overall performance of a business and to becoming more successful.
Here are 10 important things every business owner should know about financial statements:
- There are Four Basic Financial Statements
- Balance Sheet – Assets = Liabilities + Equity.
- Income Statement – Net Income = Revenue – Expenses.
- Statement of Owners Equity – Ending Equity = Beginning Equity + Investments – Withdrawals + Income.
- Statement of Cash Flows – The statement of cash flows takes into account the coming and going of cash from operating, investing and financing activities.
- Each Financial Statement Tells a Different Story about the Business
The reason there are multiple statements in financial reporting is because they contain different combinations of information that offer unique insights into a business. Here are the stories they tell:
- Balance Sheet – Shows the company’s financial position (health) at any given time.
- Income Statement – Shows how much money is coming into the business during a given time period.
- Statement of Cash Flows – Shows how cash is being moved around in a given time period.
- Statement of Owner’s Equity – Represents the change in equity for a given time period.
- Financial Reporting Reflects Real Life Events
For business owners who get overwhelmed by financial statements remember that each figure represents a real event for the business e.g. purchasing supplies, selling goods and services, getting a loan from the bank, etc. By focusing on the real events and how they impact financial reporting, the financial statements will make more sense.
- Financial Reporting is Full of Jargon
Jargon is one of the reasons why financial reporting is hard to grasp, so it is important to take the time to learn the key terms.
- Financial Reporting is Guided by GAAP
GAAP stands for Generally Accepted Accounting Principles. These are standards that guide how financial statements are recorded, summarized and prepared. GAAP is regulated by the Financial Accounting Standards Board which periodically reviews and changes GAAP as needed.
- Financial Statements Lack Important Context
Financial reporting is meant to show how a business is performing but outside contextual factors also impact performance e.g. the state of the economy or industry, competition, market forces, quality of workers, etc. As a business owner, it is important to read and interpret the financial statements with an understanding of the context that may have impacted those figures.
- For Parent Companies, Consolidated Financial Statements are Also Important
Parent companies that have a majority stake in one or more subsidiaries should prepare consolidated financial statements. These statements combine the standalone financial reporting of the parent and all subsidiaries into overall statements to better judge the health of the parent company.
- Footnotes are Also Important
There is a lot more going on behind the scenes of financial reporting than one can convey in numbers alone. Therefore financial statements also contain footnotes to explain specific accounting methods and the reasons behind financial results. It is important to look at the footnotes to get a clear understanding of the figures within the report.
- Financial Analysts Translate Figures in the Financial Statement into Ratios and Indicators
Interested parties such as the board of directors, current investors or potential investors need a more meaningful way to interpret the figures found in financial statements. Analysts will therefore take these figures and create indicators and ratios to show current company performance and projected performance for the future.
- Financial Reporting Can Help with Your Corporate Strategy
Although financial statements give a snapshot of the business at a particular time or time period, the information within can help the business plan for the future. Understanding and evaluating financial documents is crucial to business growth.
SUMMARY: Although preparing and interpreting financial statements can seem like a daunting task, the information provided from these statements can help business owners understand financial reporting at a deeper level and use the information to further improve their businesses.