When it comes to running a small business, it is extremely important that you have a strong understanding of your financial statements. In fact, they can be used as a tool for better managing your business finances, especially cash flow, and for making financial projections. To help you manage your small business finances more effectively and to gain a wider view of financial management, your financial goals, and your overall financial health, we have prepared this informative post. Let’s take a look right now.
Why Do I Need To Understand Cash Flow?
The ability of a company to generate positive cash flow determines its success and long-term financial health. As a small business owner, you need to have a grip on your cash flow if you want to avoid failure. It is one of the most fundamental things you need to master. Budgeting to ensure stable cash flow is a primary objective that every entrepreneur should focus on. Besides, research reveals that most of the businesses that fail often do so because of poor cash flow management. Therefore, you have to turn to financial statements to improve how you manage your small business finances.
Why Do I Need To Prepare Financial Statements?
Before we take a look at how to manage small business finances, you should know why you require financial statements in the first place. The fact is that financial statements provide a holistic view of your business revenue, business income, and business expenses, among many other aspects. You can rely on them to help you better manage funds and improve your overall profitability. If you are struggling to run your business and finding it difficult to achieve certain benchmarks in your business plan, you should start by looking into your financial statements. Here are some of the reasons why you have to make this a priority.
1. Allows You to Be on Top of Cash Flow
One of the main reasons you have to prepare financial statements is because they make sure that you remain on top of business finances. This level of continual information allows you to remain in control of business operations. Only when you have an idea about where you stand can you move towards your business goals. Hence, you need financial statements to help you avoid cash flow mistakes and late payments, to make sure you factor in all business transactions, marketing costs, employment and more, and to ensure that you always have enough cash on hand.
2. Improves Understanding of Your Business
Accounting is the language of business and one of the primary keys in business planning. It allows you to plan for unforeseen costs, gauge your equity or debt financing, make your monthly payments, build business savings and manage business checking, utilize business loans and business credit cards (business debt) to grow, protect yourself with business insurance, invest in the right people, and make clear, level-headed financial decisions.
The only way that you can truly understand your company, especially its financial strengths, is by going through your financial statements. They provide insight into your financial position. You get to review everything you own and owe as well as how much money you are making. This enables you to make the right decisions and steer your organization in the right direction.
3. Necessary for Filing Taxes and Applying for Loans
Whether you want to prepare taxes or get a loan, you need to have your business financial statements in hand. Otherwise, you will not know how much profit you made to correctly calculate your tax rate or burden. This will affect tax payments and compliance among other aspects of tax planning.
Similarly, no bank or lending institution will provide you with a business loan or bank loan or other forms of business funding if you are unable to provide them with your financial statements. However, these statements must show that your company is performing well in order to be granted a loan.
How Can I Use Financial Statements to Establish a Profitable Business?
Here’s how you can use each financial statement to achieve greater success as a business owner.
1. Balance Sheet
The balance sheet is easily one of the most important financial statements that a business needs to understand. It provides insight into your current financial situation. You can rely on it to see how your company is doing financially at a specific point in time.
It allows you to get an idea of what you own vs. what you owe. (debt vs assets). While it’s fine to take on loans to finance your venture (depending on payment terms), they should not be greater than your assets. You will have to keep an eye on your debts to ensure that you do not end up in an undesirable situation in either your business or your personal finances (personal accounts). Your personal accounts can affect your business finances if you aren’t careful.
2. Statement of Owner’s Equity
Another financial statement that can help you manage your business is the statement of owner’s equity. It helps you see how much income you are reinvesting or retaining. By seeing the changes in the equity over a specific period of time, you get to know which direction your company is heading so that you can make better decisions. Key data in this report will help you determine what level of reinvestment you want to commit to.
3. Income Statement
Also known as the profit-and-loss account, the income statement enables you to see how your company is doing in terms of profitability. This means that you can evaluate how much profit you are making and if you are even making a profit at all. The income statement covers a set time period, which is normally a year, and provides information about the costs incurred to offer your products or services to the public.
3. Cash Flow Statement
In the simplest of terms, the cash flow statement covers how much cash comes into your business and leaves. It is essential to find out how well your organization manages cash. Since you need cash to pay off debts, cover operating expenses and stay current during tax time, your cash flow statement should always be positive. On the other hand, if you have a negative cash flow statement, you need to be worried, since you’ll have to take on more debt and find new ways to increase the influx of cash.
How Can the 4 Financial Statements Be Used Together?
The income statement lets you know how much net income your business is bringing in, which makes its way to the owner’s equity.
The owner’s equity statement reveals whether you are in a positive or negative position. It allows you to find out whether you have a positive value for the retained earnings or not. If it is not the case, then you will have to find out how you can increase your retained earnings. It might require you to limit reinvesting.
As for the statement of cash flows, it provides an insight into what your cash position is instead of just looking at the value that appears on the balance sheet. So, you would be able to see where you are going wrong and how you can increase your cash flow and minimize losses.
The balance sheet offers a summarized view of your financial position at a specific moment in time.
How Can I Get Started?
Now, if you are wondering how you can get started with compiling these key business statements, you should consider the following tips.
1. Separate Personal and Business Finances
If you want each of the four financial statements to provide an accurate view of your financial standing, you will have to separate your personal and business finances. As we mentioned above, you need to understand that there are plenty of benefits to keeping both of these finances separate. It is one of the basic rules of running a business. Business bank accounts and business cash flow need to stay clear of personal accounts and personal finances.
2. Ensure Consistency
The secret to making the most of financial statements is consistency. You need to be consistent in order to evaluate how you are doing accurately. Studying your financial statements isn’t something you can do occasionally, only once a quarter, or simply during tax time. It is a habit you should get into weekly.
3. Consolidate the Data
Lastly, you need to consolidate your data if you want to make it work. Creating financial statements is a lot easier once you collect all your business cash flow data. For instance, you should connect your online account software with the point-of-sale credit card reader and small business account. This will ensure that you have all the information you need in one place. This will allow you to create the financial statements within minutes.
In Closing
Each of these financial statements needs to be prepared with great care and then thoroughly evaluated. You should make it a habit to review the statements to stay on top of your finances and avoid surprises. The greatest business owners in the world know their finances inside and out. It’s not something you can leave until later or hope for the best. Learn everything you can and get the professional help you need from an experienced bookkeeper or bookkeeping service provider.
Sound Accounts helps business owners succeed with superb bookkeeping solutions, tailored individually for each client. Connect with us today and discover the difference Sound Accounts can make for your business.
To learn more about small business finances, check out our frequently asked questions and answers below.
FAQ
How Do New Small Businesses Manage Finances?
In order for a small business to manage its finances, it needs to prepare and evaluate financial statements, which include the income statement, the balance sheet, the cash flow statement, and the statement of owner’s equity, among others.
Many small business owners choose to partner with a bookkeeper or bookkeeping service provider, You can also learn more by reading business blogs, books on business finances and taking classes online or in-person.
It’s good to keep an emergency fund for unexpected expenses, establish business checking, inquire about business loans, solidify your legal structure, check your personal credit rating and business credit score, invest in quality bookkeeping software, learn how to read and interpret financial reports, know your credit limit, and make financial projections and business decisions based on your bookkeeping and accounting knowledge.
What Is The Most Important Financial Statement For A Small Business?
The most important financial statement for a small business is the cash flow statement. The reason behind this is that most small businesses tend to struggle with managing operating expenses no matter what accounting methods they use or what type of business they run.
How Are Financial Statements Used In Small Businesses?
Financial statements are used by small businesses in a number of ways, such as for decision-making, seeking a loan, financial reporting, making business purchases, keeping business records, and improving cash flow.
