For small business owners, keeping a close eye on the health of their business is the key to long-term success. Especially for first-time business owners who have decided to jump in head-first, it can be very difficult and overwhelming once you realize how much work needs to be done regularly to keep up with your accounting and your ability to produce accurate financial statements that offer the information you need to know where your small business stands. There are 3 types of financial statements to be aware of, and you’ll need to know how to produce these correctly (or hire a CPA to do them for you) in order to stay on top of the health of your business, determine what’s working, and figure out where changes need to be made.
A balance sheet shows a company’s assets, liabilities, and equity balances. What the balance sheet provides is a snapshot of the company’s financial position at a particular moment in time. The importance of determining the equity of your small business lies in ensuring that your liabilities do not outweigh your assets. This is done through a simple formula:
Assets – Liabilities = Equity
According to the U.S. Chamber of Commerce: “Equity is the value of your business after deducting your liabilities from your assets. It’s the total amount of money that would be returned to your shareholders if your debt was paid off and your assets were liquidated.”
An income statement displays a company’s revenues and expenses during a period of time. The importance of an income statement is to determine returns on investments, risks, financial flexibility, and operation capabilities. Most companies choose to do a multi-step income statement because it is better at providing an in-depth look at the performance of the business. While a multi-step income statement is a much better option for understanding the true health of your business, generating these statements is incredibly labor-intensive, and the result is a lot of complex information that can be difficult to sort through.
Cash Flow Statement
A cash flow statement, also called a statement of change in financial position, shows a company’s cash inflows and outflows. Three types of business activities are used to sort cash inflows and outflows:
- Operating activities include daily business operations, such as regular sales.
- Investing activities include purchasing assets for your business, such as company vehicles, specialized equipment, and machinery.
- Financing activities include payouts from a stock or bond issue and repayments to investors.
It is recommended that investing and financing activities be calculated first when doing a cash flow statement. Any inflows and outflows that are not related to these two activities fall under operating activities, which will account for the vast majority of a company’s cash flow.
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