Financial statements are the box scores that tell everyone how your small business is doing financially. They usually contain two reports that tell the story of your finances: The Balance Sheet and The Profit and Loss Statements. The Cash Flow Statement is also important to getting the entire money picture.
How to Read Financial Statements
Small Business Trends contacted several experts to better understand how to read these important documents, starting with Derek Carter, Chief Solutions Officer for Ceterus:
The Balance Sheet
“The Balance Sheet summarizes key financial information at any point in time. It provides an efficient way to determine the health of the organization,” Carter writes in an email.
These clearly show you your assets and liabilities — in other words what you have as a small business and what you owe. Carter also says that the “current ratio” is an important benchmark because it’s a liquidity indicator. In other words, it tells the state of your liquid assets that can pay off your current debts. These types of liquid assets are generally things that can be converted into cash without losing any of their value. Accounts receivable is a good example.
Carter supplies a bottom line number.
“If the ratio is less than 1, that company could have issues paying their current liabilities.”
Stacy Caprio from Fiscal Nerd supplied an important overarching tip via email to help you have confidence the numbers you’re reading are accurate.
“When reading a financial statement, one must always be skeptical and do fact-checking if the company’s statement does not have an outside audit, as any numbers or misinformation could be on the sheet,” Caprio writes.
She also points out that publicly traded companies are required to use outside auditors.
Profit and Loss Statements
You also need to read The Profit and Loss Statements that tell you how profitable any small businesses are over a specific period of time. It’s important that you don’t take the numbers here as standalone figures. They need to have comparable data.
Carter explains:
“I suggest reviewing either several months at a time or year over year. Doing so will help you see trends that can help drive future business decisions.”
He says that spotting these trends will help you to make any adjustments quicker. For example, if sales go down for several months in a row but payroll doesn’t, it should be obvious you might need to do something with your number of employees.
The Cash Flow Statement
The Cash Flow Statement fills in any blanks. Neither The Balance Sheet or The Profit or Loss Statement tells you everything you need to know about your cash balance.
This Cash Flow Statement supplies the missing pieces in the form of all the transactions over any given period of time. It reconciles both beginning and ending cash.
It’s important to take a look at this every month to get the complete picture for where your money is going in your small business. It folds things like big asset purchases or debt transactions as well as depreciation into the big picture.
Added To Cash Balance
One of the reasons The Cash Flow Statement is so important is that The Profit and Loss Statement doesn’t tell you whether you’ve added to the cash balance or not.
Nate Masterson is the CEO of Maple Holistics. He sums up the importance of The Cash Flow Statement and how important it is to read it properly.
“These are your expenses and your profits coming together to give you a number that’s hopefully positive otherwise you may need to rethink your business plan,” he writes in an email.
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This article, “The A to Z of Financial Statements You’ll Need for your Small Business” was first published on Small Business Trends