Financial statements summarize a company’s financial performance over a period. They provide information about a company’s assets, liabilities, equity, income, expenses, and cash flows.
Why Are Financial Statements Important for Businesses?
Businesses need financial statements because they provide information that allows them to make informed decisions about the company’s future.
For example, businesses use financial statements to:
- Track the company’s financial performance over time.
- Identify areas where the company can improve.
- Make decisions about the company’s investments and financing.
- Attract investors and creditors.
- Comply with government regulations.
Track the Company’s Financial Performance Over Time
Businesses can track their progress and identify improvement areas by comparing their financial statements. For example, a company might see that its revenue has increased, but its expenses have also increased.
Identify Areas Where the Company Can Improve
Financial statements can also identify areas where a business can improve. For example, a company might see that its inventory levels are too high. This could indicate that the industry needs to sell its products more quickly.
Make Decisions About the Company’s Investments and Financing
Businesses use financial statements to decide on their assets and funding. For example, a company might see that it needs to invest in new equipment to increase production.
Attract Investors and Creditors
Investors and creditors use financial statements to assess a business’s health before investing or lending money. These statements provide information about a business’s revenue, expenses, assets, liabilities, and profitability.
Comply with Government Regulations
Some government regulations require businesses to file financial statements. The Securities and Exchange Commission (SEC) requires publicly traded companies to file financial reports with the SEC.
What is a Balance Sheet?
A balance sheet is a snapshot of a company’s financial position at a specific point in time. It lists the company’s assets, liabilities, and equity. Assets are things a company owns, liabilities are things that a company owes, and equity is the difference between assets and liabilities.
What is an Income Statement?
The income statement shows how much a company has earned over time. In addition, it lists the company’s revenue, expenses, and net income. Revenue is the money a company brings from selling its products or services, expenses are the costs incurred to generate revenue, and net income is the difference between revenue and expenses.
What is a Cash Flow Statement?
The cash flow statement shows how much cash a business has generated or used over some time. It lists the company’s operating cash flow, investing cash flow, and financing cash flow.
Operating cash flow is the cash that a business generates from its core business activities, investing cash flow is the cash that a company uses to invest in its assets, and financing cash flow is the cash a company uses to finance its operations.
How to Read Financial Statements
Reading financial statements can be daunting, but business owners must understand how to interpret them.
- Know accounting basics. You need to understand how different accounts are used to record transactions and how statements are prepared.
- Focus on the big picture. When starting, it is crucial to focus on the big picture. Stay calm in the details. Instead, focus on understanding the company’s financial performance overall.
- Compare statements over time. To understand a company’s financial performance, compare its financial statements over time. This will help you identify trends and see how the company performs relative to its past performance.
- Use statements to make decisions. The ultimate goal of reading financial statements is to use them to make informed decisions about your business.
There are many resources available to help you learn more about financial statements. Here are a few:
- The Financial Accounting Standards Board (FASB) website has a wealth of information about business finance, including tutorials, guides, and examples.
- The Small Business Administration (SBA) website has a section on financial literacy that includes articles, videos, and tools to help small business owners understand financial concepts.
- Your local library or community college may offer financial literacy classes or workshops.
- Many online resources are also available, such as Khan Academy and Investopedia.
Financial literacy is essential for business owners. By understanding financial statements, you can make informed decisions about your business and improve its chances of success.