Financial statements are part of every business as it is used for management, financial reporting and financial control. They are also critical sources of financial information used for making smart business decisions. With that being said, it is important to determine the basics when making a financial statement.
There are three important financial statements used in analysis of financial statement analysis. These are the income statement or Profit and Loss Statement (P and L statement), balance sheet and cash flow statement.
The income statement includes the following items:
1. Revenue or Sales
2. Revenue Related Expenses
3. Net Revenue (Revenue – Revenue Related Expenses)
4. COGS (Cost of Goods Sold)
5. Gross Profit
6. Operating Expenses
7. Operating Profit
8. Net Profit
While the balance sheet includes:
2. Current Assets (Cash, Accounts Receivable, Inventory)
3. Long-Term Assets (Equipment, Building, Land, Property)
4. Liabilities (Debt)
5. Current Liabilities (Accounts Payable)
6. Long-Term Liabilities
7. Owner’s Equity (Total Assets – Total Liabilities)
Lastly, the cash flow statement shows the details on the cash that the business has on the balance sheet. It includes:
1. Cash Flow from Operating Activities (Change in Accounts Receivable, Inventory, Debt, and Depreciation)
2. Cash Flow from Investing Activities (Change in Capital Expenditures and Investments)
3. Cash Flow from Financing Activities (Change in Financing such as dividends paid and purchase of stock)
These financial statements consist of the reports that summarize the company’s financial performance. By using these, you will be able to develop a good insight into your business and understand the financial performance of your company.
When creating a quick financial statement, Smallbiz1.com suggests on paying attention to the following:
The P&L Statement:
1. Look at the P&L Statement or Income Statement to see the current revenue and the trend in revenue or sales for the last periods. Is the revenue growing or is it decreasing?
2. On the P&L Statement look at the Gross Profit Margin and calculate the % Gross Margin.
3. From the P&L look at the Operating Expenses and see the percent of revenue. This will give you an idea of how high the fixed costs are in the business.
4. From the P&L look at the Net Profit Margin as a percent of sales. This shows you how profitable the business is.
The Balance Sheet:
1. On the Balance Sheet look at the ratio between assets and liabilities and see the overall structure of the company.
2. The Balance Sheet will also tell you the Owner’s Equity which is the difference between assets and liabilities or debt.
The Cash Flow Statement:
1. The Cash Flow Statement will show you how much cash on hand the company has.
2. The Cash Flow Statement will also show you and help you understand the sources of cash – for example is the cash collected or spent on financing, investing or business operations.
The Whole Package:
1. Look at the trends on all three financial statements and see the trends and pay attention to those financial trends, indicators or ratios that have substantial change over time – this reveals information about any major financial changes in the company.
2. Define the most important financial ratios or financial metrics for your business and calculate the ratios – make sure you have a simple template where you can track and monitor these financial ratios in order to identify any positive and negative changes in your business overtime. This will help you understand the trend in your business and improve by taking actions on time.
Understanding financial statements and how to do them is essential to any business, regardless of the size. This is because these reports can be used as a roadmap in order for you to locate the right direction and avoid costly breakdowns.
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