A key aspect and skill in managing a company is the ability to understand financial statements. Because we operate in a competitive business environment, it is important to be able to identify a company’s financial position/health, business trends and risks at an early stage. The ability to analyze your company’s financial statements forms a key part in cultivating overall growth.
Let us dig into the basics of financial statements:
The Balance Sheet
The foundation of the balance sheet reflects the “book value” of a company at a specific date, also known as the reporting date. The balance sheet provides a clear overview of the company and can be divided into three components namely, assets, liabilities, and owners’ equity.
Assets: Anything that the company owns or is owed, and represents an accurate quantifiable value can be attributed to this asset.
Liabilities: Any legal obligations owed by the company to third parties. In a simplistic term, liability can be seen as the opposite of an asset.
Owners’ Equity: this refers to amounts invested by or owed to shareholders. If you had to subtract all the liabilities from all the assets you should effectively arrive at the owners’ equity value. The amount reflects the net worth of the company that belongs to the shareholders.
The term “balance sheet” is indicative of one important accounting principle which is that it should always balance according to the well-known formula: Assets = Liabilities + Owners’ Equity.
The Income Statement
The income statement (also referred to as the profit & loss statement) is an accurate record summary of revenue, expenses and other transactions over a given period. This is a particularly important document that allows you to analyze the progress and performance of your company. You can easily determine if your company is making a profit or loss, analyze expenditure/costing, identify business trends, etc.
The Income statement typically includes the following basic information:
Revenue: The amount that the company earned from sales.
Costs of goods sold (COGS): This figure is the cost of what it took to produce your goods. A simple way to put it, for each product that you sold, how much did it cost to make and get it into the hands of the customer.
Gross profit: This is the total revenue less the cost of goods sold.
Operating expenses: These are costs incurred to keep your company operating but aren’t direct materials or labor related to producing your goods or services. Examples of operating expenses include property insurance and taxes, building repairs and maintenance, utilities, administrative staff wages, etc.
Operating income: This is the income amount that reflects the gross profit less the operating expenses (other than COGS).
Net income: This is the company’s profit after all expenses and taxes.
The income statement provides you with a good indication of how well your company is performing. You will also be able to analyze financial trends on profitability, excess expenditure, cost-saving and if there is any excess cash to invest back into your company.
The Cashflow Statement
This cash flow statement provides a detailed overall view of what has happened to the company’s cash and the movement of cash over a given period. It is vital that a company has enough cash on hand to meet its obligations. A cash flow statement is typically broken into three sections namely, operating activities, investing activities, and financing activities. This allows for the reader to determine the following:
- Operating activities indicate whether a company can generate cash from their normal operating activities (selling their goods or services).
- Investing activities indicate the cash earned or spent from investments. This can include buying/selling physical property, vehicles, fixed deposits, patent rights, etc.
- Financing activities indicate the cash raised/spent to settle debt and/or equity financing.
A positive cash flow figure reflects more money coming in than going out. A negative cash flow figure reflects more money flowing out (being spent) than flowing in. A negative cash flow figure is not necessarily a bad indication and this can relate to various strategic cash flow expenditure by management. The cash flow statement is vital when it comes to decision-making pertaining to the company’s cash position. It portrays the ability of a company to operate in the long term and short term based on the in and outflow of cash. Knowing this not only allows you to plan and budget in the long term, but also allows for better short-term strategical decision making.
Bringing it all together can provide meaningful information
Whilst accountants work with financial statements on a daily basis and for them it is second nature, the same cannot be said for all business professionals and it sometimes becomes difficult to understand the financial jargon. You can however learn the basics of understanding financial statements and the benefits it can yield when it comes to analyzing the statements. Financial analysis of the balance sheet, income, and cash flow statements can provide useful information such as:
- The financial health of the company
- Assist with financial forecasting, budgeting, and cash flow planning
- Maximizing gains or minimizing losses
- Identifying trends and new opportunities to grow the company
- Identifying and avoiding undue risk
- Improving and visualizing strategic business decisions
- Allows investors to analyze the profitability and market value of the company and decide whether they would like to invest
The possibilities of financial analysis and the usefulness of metrics are endless. It is important to have accurate financial statements prepared by experts that will provide you with invaluable data to analyze. The data itself won’t save your businesses – only you can.
Protea Financial is Your Outsourced Bookkeeping and Management Accounting Services:
The good news is that you can learn how to interpret financial statements even if you do not have a financial background. At Protea Financial we match our solutions to the needs of the customer. Protea Financial can support you with everything from bookkeeping services, preparing financial statements, order processing, inventory tracking, handling management accounts, and tax schedules in order to support your tax accountant. Protea’s goal is to provide timely, accurate, and high-quality financial information on which a business can act. We can work with you to provide an evaluation and find the best solution for your business.