Being in charge, running the show, the top honcho are terms
describing the president or owner of a business. Most people aspire to be at
the top of their field, be the boss, and call the shots. However, perception
and reality are not the same. With the leadership role comes responsibility for
all aspects of a company. The one area of business ownership that trips most people
up is accounting. Words such as debits, credits, and equity are new terms. As
you work your way through the unfamiliar terminology, you’ll find you need to
produce the financial statements. What makes up financial statements, and why
do you need them?
Financial statements are the language of capital. They
provide a picture of a company, which includes a business's profitability, ability to pay debts,
net worth, and inform stockholders and lenders about their investment. When a
company needs a loan, the lending institution will ask to see the financials. Before
taking a risk, they need to know if it is a smart bet.
While there are many types of accounting reports when
referring to “the financials”, the big
three are balance sheet, income statement, and cash flow statement. Each report
tells a different story about the company. Here are the basics you need to
The balance sheet is a picture of the company on one day.
The information listed includes assets, liabilities, and equity. Assets are
things of value owned by a company. Examples of assets are checking accounts,
equipment, supplies, in addition to many other items. If a business has
borrowed money or purchased assets on credit, that shows up in the Liability
column. But if an owner is investing additional funds or purchasing assets with
company profit that shows up in the equity section on the balance sheet. Equity
and liabilities on one side should equal the value of assets on the other side.
That’s why it’s called a balance sheet and it tells banks that your numbers are
The other important thing about balance sheets however is that,
for a business to grow and handle unexpected costs, an additional source of
funding is often necessary, other than just profit or owner contributions. For
these situations, companies use notes payable, lines of credit, and credit
cards. Reviewing the balance sheet, you can see if you are using too much debt to
fund the company. Ask if the profit is adequate to sustain the current business
The income statement is a picture of the company's revenue and
expenses over a specific period of time. The time specified could be monthly,
quarterly, yearly, or any period indicated on the statement. Revenue is the money
received for products or services, and expenses are the cost of doing business.
Expenses are current or long-term. Current expenses are purchasing items or
services with a useful life of less than a year and include payroll, rent, and
utilities. Long-term expenses have a useful life of more than a year and
include equipment, improvements, automobiles. The long-term expenses are
handled differently by depreciation, and we will cover it next week. Generating
more revenue than expenses is a net profit, and if you spend more than you
receive, it is a net loss.
The cash flow statement shows cash and cash equivalents (CE)
coming into and out of a company over a specific time period. The report shows how well a company can pay
debts and fund operating expenses. On
the statement, the resources are broken down by operating, investing, and
financing. Operating includes cash and CE from a company's products or
services. Investing involves funds from a company's investments and included in
this category is the purchase or sale of an asset or equipment. Financing
includes loans received and paid, as well as payments of dividends. For many
banks, cash flow is critical. When lending money, knowing a company has the
resources to pay is vital.
Recording of accounting transactions into a program is only
one step in the accounting process. Understanding the data in the system is
imperative for a company's success. Learning how to read the balance sheet, net
income, and cash flow statement is a requirement for all business owners. As
the top dog, you lead your business down the road of success.