Understanding business financials and learning how to read financial statements is an important skill that business owners and budding entrepreneurs must be able to acquire. Read on as My Business discusses the basics of business financials.
Business financials, or financial statements, are documents that contain evidence of a business’ financial activity. These documents contain important business financials data that quantifies a company’s performance and standing.
While the majority of business owners would rather leave these statements in the hands of an accounting or a finance professional, learning how to read these kinds of statements is an essential skill that could possibly save the business in the long run.
Becoming an expert in reading business financials is pretty easy, provided that business owners know how to identify what kind of financial statement they’re about to read.
So what do business financials consist of?
The four main types of business financial statements are the following:
- Income statement
- Cash flow statement
- Balance sheet/statement of financial position
- Statement of changes in shareholder equity
Income statement, or profit and loss statements, is a document containing all the necessary information regarding the profits and expenses of a business. It reports how a business has performed within a certain time period.
The income statement is divided into income and expense: with income highlighting business earnings including dividend income and sales revenue and expense outlining the costs incurred by the business such as salaries, rent fees, depreciation and other miscellaneous fees.
Income statements deduct total business losses from business profits, with the result reported as the business’ total net income. This net income is usually placed at the bottom part of the document.
Learning how to read the elements of an income statement can help business owners keep track of business expenses. The income statement can also be compared with the business’ budget plan when creating a spending plan for the next fiscal year.
Cash flow statement
Cash flow statements are documents which illustrate a business’ cash outflows and inflows over a certain period and within three major categories—operating activities, investing activities and financing activities.
Operating activities highlights cash flow from primary activities, investing activities includes cash flow coming from asset purchases and financing activities contain cash flow from repayments of share capital and debt as well as interest and dividend payments.
Cash flow statements help businesses distinguish between cash coming from a customer and cash coming from a loan. This is essential for a business’ overall growth as it helps business owners develop the necessary resources needed to plan for future expenditures.
Cash flow statements also include the business’ ending cash balance which can be calculated by using the formula below:
Beginning cash balance + cash inflows - cash outflows = ending cash balance
Balance sheet/statement of financial position
The balance sheet, or statement of financial position, contains reports regarding business assets and its accompanying ownership properties. This particular financial statement outlines a business’ current financial position.
It is further subdivided into three major categories, namely equity, assets and liabilities. Equity allows businesses to distinguish between assets and liabilities by outlining the remaining capital after the business uses its assets to pay off liabilities, assets outline the total amount of what the business owns and liabilities outline just how much the business owes.
Liabilities can be further broken down into short-term and long-term debt. Short-term debt usually includes taxes and accounts payables, while items such as payable stockholder notes and bank loans fall under long-term debt.
Statements of financial position are deemed useful within a shorter period as it is the sole financial statement that outlines a business’ current condition.
Compared to other financial statements, cash flow statements and income statements only show aggregated data throughout a given period. The immediacy of the data found in balance sheets makes it very ideal for solvency and liquidity analysis for businesses and corporations.
Statement of changes in shareholder equity
The statement of changes in equity, or the statement of retained earnings, highlights the ownership stake in a business and the changes in owner equity within a given timeframe.
Large corporations make use of this particular financial statement to track significant changes in dividends, income, retained earnings, private equity issuances and other income sources—which are also the main categories found in this financial document.
Information found in statements of retained earnings are utilised by investors who want to determine how much of the business is being financed by income and capital and compare this amount with the business’ outstanding debt.