Understanding Financial Statements

Understanding financial statements and how to read financial statements it is not only required for tax purposes, but it is useful information that can enable a business owner to dissect the state of their business successes and failures. The information contained in business financial statements can help a business owner to modify the current business plan or to make changes that foster business success. The key business financial statements include the profit and loss statement, the balance sheet and the cash flow statement.

Profit and Loss Statement

Profit and loss statements (P&Ls) reflect the business’s sales and expenses over a measured period of time. This statement is considered to be an indication of the business’s strength and progress on a continuing basis and is commonly compared to prior periods.  This statement is also required by the IRS to determine the taxed owed for the business during a given period of time.

A profit and loss statement will contain the following information about the business during a given period of time:

  • Net sales
  • Cost of goods sold
  • Expenses
  • Other revenues and expenses

Depending on the period measured, a business may show either a profit or a loss. It is important to understand the period being measured and the activities that took place during the period to gain a proper understanding of the business’s financial health.

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The Balance Sheet

The balance sheet is a reflection of the business’s net worth. A balance sheet depicts the business’s assets and liabilities, both short-term and long-term. Balance sheets are commonly prepared at month-end, quarter-end and yearly as they are a great tool for business owners to use when steering the direction of the business. All the business’s assets including accounts receivable, cash, inventory, notes payable and other investments should be listed. The business’s debt, both short-term (1-year or less) and long-term (1-year+) will be listed under the liabilities section. The business’s net worth is determined by taking the total assets minus the total liabilities.

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Cash Flow Statement

The cash flow statement is simply that; a statement of cash flow through the business during a specified period of time. But, cash flow statements do not show net profit from the business, merely total cash flow through the business. The categories of information collected on a cash flow statement include:

  • Operating activities- cash receipts, payroll, supplier and vendor payments, rent or lease payments, tax payments and utility payments
  • Investing activities- long-term investments into machinery, equipment, land, buildings and other leasehold improvements
  • Financing information- changes in the stock or debt/bond issuance for the company

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