Bookkeeping Basics for Small Businesses

Financial reporting is crucial for understanding your company's financial position and ensuring its success. It provides an objective assessment of your company's financial health through the creation of a financial statement. This statement can reveal whether your company is profitable or facing challenges. Let's explore the basics of financial statements and their practical application.

What are financial statements?

Financial statements are essential reports that provide information about a company's financial performance and profitability over a given period. The three main types of financial statements are balance sheets, income statements (or profit and loss statements), and cash flow statements. Additionally, business owners may occasionally refer to other financial reports, like the statement of retained earnings.

Why do financial statements matter?

The reason financial statements are so important is because they allow stakeholders to assess a company's financial performance and health. They are especially important for lenders when evaluating eligibility for a business loan. Plus — public companies are required to publish their financial statements in annual reports.

Financial statements offer valuable insights into a business's economic resources, obligations, earning capacity, potential cash flows, management status, and accounting policies.

Financial statements are crucial for business owners to gain insights into their bottom lines and make informed decisions. Utilizing accounting software can simplify the process of generating these statements.

How to prepare a financial statement

In a nutshell, financial statements are prepared by applying basic accounting principles to ensure accuracy and consistency. This involves recording facts, following accounting conventions, and making personal judgments. By understanding these principles, you can create various reports that comprise financial statements.

What are the 3 types of financial statements?

In financial reporting, business owners can rely on three crucial tools for effective management:

1. Balance sheet
2. Income statement
3. Cash flow

These tools provide valuable insights into the financial health and performance of a business.

Balance sheet

A balance sheet is a financial statement that presents a company's assets, liabilities, and equity balances at a specific moment. It provides a snapshot of a business's financial position, highlighting three key categories: assets, liabilities, and equity.

• Assets generate revenue and profits in a business. They can be tangible, like a vehicle, or intangible, like a patent or intellectual property.
• Liabilities are financial obligations that a business owes to other parties. These can include accounts payable, which are short-term liabilities representing unpaid bills and invoices, and long-term debt, which refers to borrowings and financial obligations that extend beyond one year.
• Equity is the true value of a business, calculated as the difference between assets and liabilities. It encompasses common stock, additional paid-in capital, and retained earnings. Also referred to as shareholder's equity, owner's equity, or net worth.

The balance sheet formula is a fundamental concept in accounting. It calculates equity by subtracting liabilities from assets. This formula ensures that the accounting equation stays in balance as transactions occur. Balance sheet accounts use this formula to calculate important ratios, such as working capital.

Income statement

An income statement, also known as a profit and loss statement, is a financial document that provides a snapshot of a company's financial performance over a specific period. It shows the revenues, costs, and expenses incurred during that period, allowing stakeholders to see the profit or loss the company generated.

Your statement is divided into operating and non-operating sections. The operating section discloses revenue and expenses related to the company's primary activities, while the non-operating section displays income and expenditure resulting from secondary activities.

By comparing income statements from different periods, you'll be able to track your company's financial progress and make informed business decisions.

Cash flow statement

A cash flow statement is a financial document that provides a detailed analysis of a company's cash inflows and outflows during a specific period. This will be divided into three sections: operating activities, investing activities, and financing activities.

The operating section presents cash flow from daily business operations like sales revenue and expenses. Investing activities depict cash from the purchase or sale of assets, such as property or equipment. The financing section shows cash from borrowing or repaying loans, issuing shares, or paying dividends.

Understanding the cash flow statement is crucial as it provides insight into a company's liquidity and solvency, and its ability to fund operations and growth internally.

Understanding the different types of financial statements

The biggest difference between your balance sheet, income statement, and cash flow statement lies in their focus areas.

• An income statement emphasizes a company's profitability over a specific period by analyzing revenues and expenses.
• A cash flow statement, on the other hand, focuses on liquidity by examining cash inflows and outflows in operating, investing, and financing activities during a particular period.
• Meanwhile, a balance sheet provides a snapshot of a company's overall financial health at a specific point in time, showcasing its assets, liabilities, and shareholders' equity.

While interconnected, these three statements each provide unique and crucial insights into different aspects of your company's financial status. At M3 Bookkeeping Solutions, we will work with you to develop each of these reports so you can make informed financial decisions going forward.