One aspect of a properly managed business is the maintenance of accurate records through financial statements. They help you keep track of your inventory, sales, purchases, expenses, cash flow position, debt, and other indicators. The generally accepted accounting principles (GAAP) prioritize these three main statements: The cash flow statement, income statement, and balance sheet.
A Statement of Retained Earnings also comes in handy if you’re interested in attracting investors. It contains information about your net income and how you distribute it in the form of dividends. Financial statements give a snapshot of your company’s overall health to potential investors, financiers, regulators, and other relevant stakeholders.
Cash Flow Statement
This document shows a summary of the cash or cash equivalents flowing in and out of your business. It indicates the company’s ability to finance operating expenses and pay debts. You may break it down into three categories:
1. Operating activities: This type of cash flow evaluates the direct costs and income generation associated with production and sales. They include advertising, vendor payments, interest paid or received, depreciation, and the purchase of raw materials.
2. Investing activities: It tracks cash spending on equipment, property, principal loan payments, and long-term investments such as bonds.
3. Financing activities: This category covers cash input and output from shareholders, investors, creditors, employee stock options, and dividend payments. The cash flow statement is essential in various ways. It assists with investor attraction, debt reduction, stock buybacks, company acquisitions, calculating dividend payments, and re-investing in the business.
Also referred to as a profit and loss statement, this document compiles your expenses and revenues over a particular period. To prepare an income statement, you must first choose a reporting period, then create a trial balance report. The next steps involve calculating total sales revenue and cost of sold goods.
Determine your gross margin by deducting the value of goods sold from your total revenue. Compile your total operating expenses as listed in the trial balance, then record them as selling and administrative expenses. You’ll get your pretax income by subtracting these costs from your gross margin. Finally, deduct your income tax from this figure to determine your net income. An income statement is important because it shows whether you’ve made a net profit or loss.
This statement provides a summary of your company’s assets and liabilities, as well as owners’ equity over a given period. It’s used as a source document when analyzing its capital structure and calculating the rates of return. This financial statement by itself can’t provide an analysis of long-term trends but is useful when compared to past balance sheets or those of similar companies.
You can also use it to determine four crucial ratios. One of them is the net working capital. It shows the amount of money you would have if you paid off all short-term debts and remained with your current assets. The second one is the debt-to-asset ratio, which calculates the value of assets that your business purchased through debt. Others are current and quick ratios and solvency ratios.
Statement of Retained Earnings
Retained earnings refer to the portion of your business profits that you reserve for reinvestment instead of distributing to shareholders. Apart from using these funds as working capital, you can also utilize them to facilitate debt payments and purchase fixed assets.
Retained earnings appear in the balance sheet in the stockholders’ equity section. They represent a valuable connection between your balance sheet and the income statement. Your net income and dividend payments have a direct impact on your retained earnings balance.
How to Prepare Your Financial Statements
The accounting cycle has the following eight steps, which are appropriate when preparing financial statements:
- Identify the relevant transaction and record it accordingly.
- Create journal entries for every transaction depending on whether you use the cash or accrual accounting method.
- Post these transactions to the relevant accounts in a general ledger.
- Prepare a trial balance at the end of the accounting period.
- Create a worksheet and use it to balance credits and debits.
- Make the necessary adjustments to your journal entries.
- Use the previous entries to create your financial statements.
- Close your books at the end of the accounting period and prepare a performance analysis.
If you use accounting software, it will automatically create these entries for you. It’s advisable to hire a professional accountant for a comprehensive analysis of the impact of financial statements on your business.
The Data You Need to Run Your Business
Data is one of the most precious resources in the modern world. Financial statements help you analyze your company’s performance and meet your overall business objectives. It shows you which aspects of your business are doing well and the ones that need improvement. It also makes it easy for regulators, bankers, suppliers, and other stakeholders to partner with you. Hiring a professional accountant helps ensure accuracy. It also allows you to enjoy all these benefits while focusing on your core business.