Introduction To Financial Statements (Part 1)

Financial statements are important as they show you where your money comes from, where your money is, and where your money has gone in your business.

As a business owner, it is imperative to keep a close eye on your financial position. It may not be as sexy as developing new products or marketing campaigns but it is necessary to your business’s survival.

The good news is you do not need to be an accountant to read financial statements. The basics of accounting are simple. If you can follow a story, you can learn basic accounting. So, anyone can learn to read basic financial statements.

There are three main financial statements:

  1. Balance sheets: Shows what your company owns at a fixed point in time.
  2. Income statements: Show how much money your company made and spent over a period of time.
  3. Cash flow statements: Show the exchange of money between your company and the outside world over a period of time.

Balance Sheets

A balance sheet provides detailed information about a company’s assets, liabilities and shareholders’ equity.

Assets are what your business owns that has value. This typically means they can either be sold or used by the company to make products or provide services that can be sold. Assets include physical property, such as plants, trucks, equipment and inventory.

There are also intangible assets that can’t be touched but nevertheless exist and have value, such as websites, trademarks, and patents. Cash and property are also assets. So are the savings and investments your business accumulates.

Liabilities are the debts that your business owes. This can include long term and short term obligations. Liabilities are money owed to suppliers for materials, the payroll you owe employees, environmental cleanup costs, or taxes owed to the government. Liabilities also include obligations to provide products or services to customers in the future. Long term debts are notes or mortgages paid usually over years.

Shareholders’ equity is sometimes called capital or net worth. This is the money that would be left if you sold all of your business assets and paid off all of your business liabilities. This leftover money, or owner’s equity, belongs to you, the shareholder or owner.

The accounting formula for a balance sheet is:

Assets = Liabilities + Owner’s Equity

Your company’s balance sheet is set up like the basic accounting equation shown above. On the left side of the balance sheet, you list assets. On the right side, you list liabilities and shareholders’ equity.

Assets are generally listed based on how soon they will be converted into cash. Current assets are things a company expects to convert to cash within one year. A good example is inventory. Most companies expect to sell their inventory for cash within one year.

Noncurrent assets are things you do not expect to convert to cash within one year. They include fixed assets. Fixed assets are assets used to operate the business but that are not available for sale, such as vehicles, computers, furniture and other property.

Liabilities are generally listed in the order they are due. Liabilities are also labeled as either current or long-term. Current liabilities are obligations a company expects to pay off within the year. Long-term liabilities are obligations due in more than one year.

Shareholders’ equity is the amount owners invested in the company’s stock plus or minus the company’s earnings or losses since inception. When a company distributes earnings, instead of retaining them, they are called dividends.

A balance sheet shows your assets, liabilities, and shareholders’ equity at the end of the reporting period. It does not show the flows into and out of the accounts during the period.

For more information on income and cash flow statements, click here to read Introduction To Financial Statements (Part 2).


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