When starting a company or managing a business, it’s easy to overlook certain things. Our hands are full of so many concerns. One thing you should never forget is your finances. Not only do major corporations need to keep an eye on their numbers, but the success of small business owners depends heavily on managing resources well and gaining a deep understanding of reports and analytics. 

The numbers tell us about the financial health of our company in multiple areas. Only when you have the right information, can you expect to make the right business decisions. This affects decisions like when to hire someone, the purchase of inventory, market pricing, departmental resource allocation, new investments, product development, and expansion. Although bank statements might provide some level of insight into your financials, they are just never going to be enough to manage a business effectively.

You need in-depth metrics to make sense of many factors, like determining how long your company can survive without cash and how long it takes for sales to bring cash, referred to as the cash conversion cycle. 

If you want a comprehensive understanding of your business’s financial health, there are a few reports that every small business owner needs to understand. These include a balance sheet, income statement, and a statement of cash flow. Each of these provides valuable data for assisting with key decision-making.

These three financial reports are interrelated and you need to understand each of them to unlock the true potential of your business. Let’s take a brief look at each one. 

1. Balance Sheet

One of the most important financial reports that you need to understand is your balance sheet. It reveals what you own in comparison to what you owe. A quick glance at a balance sheet will show you the value of your company’s assets at a specific date (i.e. today), the money that debtors owe you, and how much you owe creditors. In addition to this, it would also mention initial investments and equity over time.

In order for a balance sheet to be considered accurate, it must balance. This means that both sides of the report have to balance. Keep in mind that the money you borrow would be considered both a liability and an asset, as it would appear on both sides of the balance sheet. For instance, if you take a 3-year loan of $5,000 from your bank, it would appear in the financial report as $5,000 in cash and $5,000 in liabilities. Thus, the equation would balance the statement.

The following equation is used for preparing an entire balance sheet.

Assets = Equity + Liabilities

To better understand a balance sheet, you should view it in personal terms. We all have a balance sheet in our lives. Our personal balance sheets include how much money we owe on a mortgage, credit card bills, interest on student loans, and the cash in our bank accounts. The same goes for your business. Cash refers to the money that you have on hand, whereas, accounts receivable is how much money you are entitled to receive for providing a product or service. It is vital that you keep an eye on this number.

For instance, when you provide products on credit terms, your accounts receivable would be much higher than your cash at hand. Perhaps your clients might default on payments. In such a situation, you should consider charging a retainer, especially when dealing with first-timers.

Inventory is an asset that you can sell to receive cash. Similarly, prepaid expenses such as marketing and rent are also an asset. On the other hand, liabilities are on the opposite side of the equation and account for what you owe. The two most common liabilities that small businesses have are accounts payable and credit. The amount is owed to suppliers and vendors. Then, there is equity, which serves as your net worth. It is defined as the difference between what you own and what you owe. Hence, you can learn a lot about a company by viewing its balance sheet. You need to find out if the debt owed is higher than the assets owned. Moreover, you also have to know how long it would take for sales to convert into cash.

Some additional important information that you can obtain from the balance sheet is mentioned below.

Cash Conversion Cycle: This ratio determines how long it takes for sales to provide cash. It is important as it allows you to find out whether to trade in cash only or provide credit terms.

Working Capital: It is calculated by deducting current liabilities from current assets. The formula is used for finding out how much money you have for daily operations.

Debt Ratio: This is used to find the ratio of debt to assets.

Sales and Inventory Ratios: If you hold inventory, you can use these ratios to find out how quickly the inventory converts into cash after-sales.

2. Income Statement

The next financial report that you need to know is your income statement. It is used for determining profit or loss over time, usually a year. An income statement is necessary for finding out if a business is profitable or not. It includes sales, cost of goods sold, and operating expenses. Every entrepreneur has to know how to read an income statement to better understand the finer points of their finances. There are two sets of transactions that are mentioned in this financial report. They include operating revenue and expenses which relate to the cost incurred for directly generating the revenue and non-operating expenses such as tax.

A great thing about an income statement is that you can easily adjust it to suit your requirements. Whether you require an income statement for a month or a year, you should be able to generate it for the desired period using accounting software. For instance, if you have two revenue streams, which include cosmetics and hair products, you can create an income statement to find out how much profit each product is generating for you. The following are some crucial indicators that you need to evaluate using your income statement.

Burn Rate: This is the amount of money a business loses each month. Specifically, it measures how long it takes you to spend money on the business.

Net Profit Growth Rate: It measures the increase or decrease in revenue by comparing two income statements.

Net Profit Margin: It is the ratio of net profit to sales revenue.

3. Statement of Cash Flow

Lastly, you’ll need to know what a statement of cash flow has to offer. Small business owners tend to neglect this integral financial report and simply focus on the income statement and balance sheet. However, it can make or break a business. The statement of cash flow maps out how cash and cash equivalents enter your business and leave. It merges both the balance and income statement to provide valuable insights.

A valuable metric that you need to calculate using the statement of cash flow includes sources of cash. It allows you to find out how much money you are receiving within a given period and where the money originates. You might accumulate money by getting a loan, fundraising, selling stock, or through sales. Negative cash flow would indicate that your business is having trouble meeting expenses. This is why it’s important that you learn to better manage your cash flow, as it would serve as a cushion for your continued efforts.  

The statement of cash flow provides an overview into where cash is coming from and where it is going, which you cannot expect to determine with an income statement alone. For instance, when your bank account has a large deposit, it doesn’t mean your sales have increased. Instead, you might have taken out a loan. There is plenty of information you can gather with a statement of cash flow. Never underestimate its importance. 

Conclusion

Each of the above financial statements is necessary for evaluating the performance of your small business. You can use the information for making both short-term and long-term decisions. In addition to this, the bank will ask you to submit these statements to determine if you qualify for a loan or not. When you immerse yourself in accounting, you get to gather valuable insights. With professional bookkeeping services, you get to hire an expert to prepare these three financial reports for your business so that you can make the best decisions.

Sound Accounts is your ideal small business bookkeeping partner. We help business owners from every market sector organize, analyze, and capitalize on their financial info. Contact us today and discover the difference excellent bookkeeping and financial knowledge can have on your growth. 

Check out our frequently asked questions below for quick information about taking advantage of your financial reports. 

FAQ

Why is it important to monitor and understand my financial reports?

Using your accounting software and partnering with your bookkeeper to print and analyze your reports gives you the vital information you need to see your current performance clearly, uncover problems, reallocate funds, spot trends, and make decisions for growth with much more accuracy. 

Financial reports include an incredible amount of data related to your spending, debts, assets, investments, departmental performance, revenue and so much more. There is simply no way of accurately or confidently managing a business without a clear understanding of every aspect of your company’s finances. 

Besides the three important reports mentioned above, what are some other financial reports I should always be aware of?

Some other good reports include Accounts Receivable, Net Profit Margin Over Time, Budget vs. Actual Report, AR Days vs. AP Days and more. 

How do I make sure I’m making the most of my financial reports?

You should be tracking your info and studying it consistently, preferably on a daily basis. Set aside time each day to focus on your financial health and toward making projections and decisions based upon the information gathered. 

Most of all, it’s a good idea to partner with an experienced bookkeeper to help you make sense of your data, spot details you may overlook, explain financial info in easily understood ways, and help you decide on a plan of action for the next season.