What is a Financial Statement? The 5 Statements You Need for Success
As an entrepreneur, you’ve been working hard to build your business. You have a great product or service, and the customers are starting to come in and spend money! Congratulations – you've begun to achieve what few other new business owners have.
However, as the money rolls in and the expenses pile up, you realize that you have no idea how to manage your money. How much is going out, and how much is coming in?
Don't worry! A set of financial statements can help you answer all of these questions. In this article, we'll explore the five most common types of financial statements – highlighting each one's role in helping you manage your business. We'll also share some tips for understanding financial statements, even if you're not an accounting expert!
What is a Financial Statement?
Financial statements are a snapshot of your business's financial condition. These reports provide an overview of how well (or poorly) your company is doing financially and offer critical insights into how healthy your finances really are. Over time, you'll be able to track trends in income, spending, and cash flow – allowing you to better plan for the future. In general, there are five financial statements you will need to know about:
Income Statement
Balance Sheet
Statement of Change in Equity
Statement of Cash Flow
Noted to Financial Statements
As you read through this article, keep in mind that financial statements are tools that help you answer specific questions about your company's finances! Over the course of running a business, you'll constantly use your financial statements to track key performance metrics – and will become a roadmap to your future success.
1. Income Statement
The first and possibly the most important financial statement is the income statement. This report helps you track how much money your business brought in and how much it spent over a certain time period. The income statement records all of the revenue that your business generated, as well as any expenses it paid out during a specific interval. Revenue includes all money that comes into your business as a result of sales and is typically called the top line.
Expenses consist of the money you pay to run your business, from salaries to office supplies, typically called the bottom line. Since they track how much money came in and how much went out, they can help you identify whether or not your business is profitable. If you're just starting out, the income statement will be based on estimates – but over time, you'll be able to look back and see how much cash revenue is coming in (and what you're spending it on).
Income Statement vs. Profit & Loss Statement
You may have heard the term “profit and loss statement” when it comes to financial statements. This report is very similar to an income statement. However, instead of focusing on revenue and expenses, it focuses solely on how much money your business made or lost during a specific period.
2. Balance Sheet
The next financial statement is the balance sheet, which shows you an overview of your business's total assets and liabilities – or what your company “owes” and “owns.” Your balance sheet records all of your business's current assets (what it has to work with) and current liabilities (what it owes), so you can get an idea of your company's overall financial situation.
While the income statement shows you what happened over a certain amount of time, the balance sheet is always up-to-date. This is why it's often called a snapshot of your company's finances at any given moment in time. If your business is profitable, the balance sheet will show you how much money it has in assets to cover any outstanding liabilities. If you're struggling financially, this report can help identify where your issues are coming from – allowing you to get back on track!
3. Statement of Cash Flow
The statement of cash flow tells you how much money your business had in its checking account (or other liquid assets) at the end of a specific period. The statement of cash flow is similar to the income statement, except instead of looking back at how much revenue you brought in – it focuses on how much money is coming into (and leaving) your business. It can help you measure your company's profitability at any given time since it will show you the difference between cash coming in (revenue) and cash going out (expenses).
As long as your business is profitable, you're doing well. However, if you start to see this statement drop lower than the income statement, there's a good chance you're spending more than you're bringing in.
4. Statement of Change in Equity
In addition to the income statement and balance sheet, there's also a statement of change in equity that shows how your business is doing financially from one period to another. Like the other financial statements, it's made up of account balances at a given time, but these accounts are taken from two different reports.
The statement of change in equity shows you the changes that happened within your income statement and balance sheet – so you can see how they impact your business. For example, say you have $50,000 in total assets at the beginning of a year. But by the end of it, you have $55,000 even though revenue stayed the same. This statement will show you where your assets came from (in this case, it was probably due to something like reinvesting in your business).
This statement isn't often included in the "big three" of financial statements. However, it is still incredibly important for business owners because it can help you identify where your growth is coming from.
5. Notes to Financial Statements
Finally, the complete set of financial statements will include what is known as the "Notes to Financial Statements." This document helps you understand the numbers behind the financial statements – like why certain things were included and how they impact your business.
The notes to your financial statements is another critical tool that helps you make sense of all those numbers – it goes into detail about what went into calculating each part of your business's reports. It can help you identify trends, learn helpful information about your industry, and find specific details like how much it costs to grow vegetables!
This document is especially helpful for accountants and stakeholders who might not have full knowledge of your business.
The Benefits of Financial Statements
As you can see, there are a few things that financial statements offer small business owners. These reports show you everything from how much money your business has in assets to how it's developing throughout the year – helping you make better-informed decisions about your company's future. Knowing what your financial situation is at a given time is incredibly important. Because if you don't know whether or not your business is losing money or bringing in more than it is spending, how can you make a plan to fix things?
The financial statements also offer a helpful way for businesses to benchmark their success. This will allow them to see where they measure up against similar companies and help predict how much growth they could see in the coming years. This is also helpful for business owners who might not have a finance background but still want to get an idea of their financial situation. The notes included with these reports can help individuals learn more about what goes into accounting – so they know how to best support your business's needs.
And while you don't want to use these reports as your only source of information, they can help you make better decisions about how to develop your business – whether that's growing, scaling back, or thinking about an exit strategy.
Learn More with 137 Awareness
Learning how to create and utilize financial statements is one part of the journey to financial wellness. When used properly, financial statements can help you keep track of your business's growth and progress.
At 137 Awareness, our team of financial experts is trained in helping you grow your business and creating financial plans that work for you. Because when you know where your money is and how to use it most effectively, making smart decisions about taste, growth, and development becomes a lot easier! To learn more, set up a consultation with a 137 Awareness financial coach today. We also offer free resources and articles aimed at helping entrepreneurs learn how to navigate their business journey no matter their stage or age!
Click below to download a free chapter of our eBook "Running a Business Like a Business.” This incredible resource is chock-full of our latest tips, insights, and methods for helping you build a competitive edge in your industry and prepare for the unexpected.
