What do The Numbers Say? A Quick Guide to Understanding Financial Statements

Your financial statements are essentially your business’ report card. 

These tell you how much your business has, how much you owe, your running expenses and the income coming in month-to-month.

Each of these metrics is central to your business success. However, this information only becomes useful if you can analyze and understand what is there.

This guide will touch on some of the common entries you will find in your financial statements.

Balance Sheet

Balance sheets show your company’s liabilities, assets, and amounts held by shareholders. 

This information can help you determine what your company is worth and can alert you of potential issues before they occur. 

The following are standard terms you find in a balance sheet and what they mean. 

Assets: Items of quantifiable value that are owned by the company

Liabilities: This is money your company owes. This includes debts, payroll, taxes, rent and utilities, and so on. 

Owners’ equity: The money you would have after selling your assets and paying off all liabilities. 

Income Statement

Also known as the profit and loss (P&L), it gives a summary of the impact of your gain, revenue, loss transactions, and expenses for a given duration.

While a balance sheet cannot help with trends, an income statement can help you see business trends and make comparisons over different periods. Here are some terms you should be aware of.

Revenue: Amounts of money your business brings in

Expenses: Money the business spends

Cost of goods sold: Total cost of everything required to produce the products your business deals in

Gross profit: Total revenue less cost of goods sold

Operating income: Gross profit less operating costs

Income before taxes: Operating income minus non-operating expenses

Depreciation: The value your assets have lost over time

Accountants, business owners, and investors use this information to determine financial trends, ascertain profitability, costs of doing business, and so on. 

Cash Flow Statement

Cash flow mismanagement is one of the top reasons why businesses fail. 

A cash flow statement gives an in-depth look at where your business cash went during a specified financial period. It’s also a good indicator of how well your business can operate in the long and short term.  

Cash flow has three subsections:

Cash Flow From Operating Activities

This includes both revenues and expenses and represents cash flow generated from providing goods and services. 

Investing Activity Cashflow

This is cash resulting from selling or purchasing assets. If your business has sold any of its assets in cash, the information reflects in this section.

Cash Flow From Financial Activities 

This represents cash flow from both equity and debt financing. It shows how a business raises capital and repays it through capital markets.

Cash flow statements are typically used to determine which actions generate cash. This helps in making financial decisions. 

Annual Reports

If you are running a public corporation, you are required to publish your annual reports for shareholders. 

This is a far much more detailed report that the other financial statements discussed above. 

While it includes a company’s balance sheets, income, and cash flow statements, it also provides additional information such as accounting policies, MD&A’s, and insights. 

This report is not mandated for small, private businesses, but entrepreneurs find that having such a report helps them get a better sense of their business’ financial standing.

Similarly, understanding these reports helps you make sound decisions when looking to invest in other companies.

One More Thing

As you have probably noticed, these reports work best when analyzed cumulatively.

Individually, each report gives you valuable information about your business, but not enough to provide you with the bigger picture. With all the different parts of each report, it can indeed get complex.

Successful entrepreneurs find that taking an accounting course or having a trusted accountant helps them understand their financial information, and ultimately make better decisions regarding their businesses.