The Ins and Outs of Financial Statements

Aug. 4, 2022

You might think that financial statements are primarily a concern for accountants or other finance specialists. However, business owners, executives, and managerial staff need to understand this business aspect clearly.

When business professionals learn the ins and outs of financial statements, they can pinpoint the strategies that lead to optimal business decisions. This is possible because all crucial information becomes clear and readily available.

This article will tell you all you need to know about financial statements and help you understand the valuable information they hold.

What Are Financial Statements?

In essence, financial statements allow you to see where the money is going, where it’s coming from, and where it is currently. When you understand the financial status of your organization, you can get a clearer idea of its potential future performance. However, this isn’t only useful for making internal business decisions. Financial statements also play a significant role in taxes, audits, investing, and financing.

Your financial statements include key information about your company’s assets, liabilities, equity, revenues, gains, expenses, income, losses, and cash flow. Of course, a single statement won’t contain every possible piece of information. Instead, different statements will show different pieces of data.

The types of financial statements are:

  • Balance sheet
  • Income statement
  • Cash flow statement
  • Annual report

These statements will give you a complete picture of profits, expenses, and your company’s financial future. They’ll also inform any external stakeholders about your business’s financial standing. Lenders can assess the risk levels when approving loans, and your accountants can get all of the data necessary to complete tax returns. 

Financial statements provide a comprehensive record of your business activities. This allows for future comparisons, more accurate predictions, and better planning.

Essential Financial Statements

Let’s look at the different types of financial statements and what each contains.

Balance Sheet

This financial statement lists company resources and financing details within a designated period. The balance sheet also provides information on assets, liabilities, and owner’s equity. 

Company assets represent everything the company owns that has a quantifiable value. You can liquidate these assets to produce cash, and they can fall into one of two categories: current and noncurrent.

Current assets are those the company can expect to convert within a single year. They include cash, inventory, and more. Noncurrent assets represent long-term investments that a company likely won’t convert. These assets can range from intellectual property and patents to trademarks, land, and the company’s brands.

A liability is any debt, including rent, outstanding payments, taxes, and bonds payable. Like assets, liabilities can also be current and noncurrent, depending on whether the debt is due within a year or longer. Current liabilities often include rent, debt financing, and payrolls, while noncurrent liabilities are bonds payable, pension provisions, loans, and leases.

The owner’s equity describes the company’s net worth. If the business paid off all liabilities and sold all of its assets, the owner’s equity is everything that is left. 

You might notice that the balance sheet provides an elementary understanding of a company’s financials. The information in this statement is undoubtedly valuable but not sufficient to give any more profound insight. That’s where the following financial statements come in to clarify the situation.

Income Statement

The income statement is also called the Profit & Loss statement. This extensive report includes detailed information about revenue, expenses, net income, and many other vital metrics. It shines a light on noticeable trends, important company activities, and performance comparisons between various periods.

The information in the income statement includes:

  • Revenue
  • Expenses
  • Cost of goods sold
  • Gross profit
  • Operating income
  • Income before taxes
  • Net income
  • Earning per share
  • Depreciation

Revenue and expenses are relatively straightforward terms. Revenue is how much money a company is taking in, and expenses are how much the company is spending.

The cost of goods sold is an important metric that shows the expenses necessary to deliver a product or service. You can find your gross profit by subtracting the costs of goods sold from the total revenue.

Operating income and income before taxes refer to your income when you subtract operating and non-operating expenses, respectively. You get your net income when you then subtract taxes.

Earning per share is calculated by dividing the net income by the number of outstanding shares.

Depreciation shows how much the value of business assets has reduced over time.

Finally, EBITDA is an acronym that stands for “earnings before interest, taxes, depreciation, and amortization.”

Income statements can be analyzed vertically and horizontally, with each analysis method providing specific insights.

Vertical income statement analysis lists every item within the statement as a base figure percentage. You can easily read each column and understand how each data entry relates to the others. Vertical analysis is helpful when comparing financials between different periods, companies, and even industries. It provides a view into how each metric progresses and whether it’s improving or declining.

A horizontal analysis takes actual dollar values into account and assesses the changes across reporting periods. This showcases the consistency of a company and how it compares to the competition in terms of growth. Analysts and investors can use horizontal analysis to spot the primary performance drivers and determine specific patterns.

The income statement can prove extremely useful in business analysis, planning, and predictions. You can use the information gathered in this document to understand if your company’s profitable and if you can afford to invest additional funds to grow your business.

Cash Flow Statement

The cash flow statement gives you a clear picture of your company’s cash flow within the accounting period. Knowing how cash flows in and out can speak volumes about your business operations. This information can be valuable for short-term reactions, adjustments, and long-term planning.

You can calculate cash flow directly or indirectly. The direct method takes the cash that went out of the company through regular operations and subtracts it from the cash that came in the same way. You do this method with data from a specific period. The indirect method considers accrued cash flow data from periods when no cash came in or went out of the business through standard operations. This separates the operational cash flow from the company’s net income.

A cash flow statement has three sections: operating, investing, and financing activities.

Operating activities describe what happens to the cash flow after it comes in through sales or you deliver a product or service. This section deals with revenue and expenses.

Investing activities refer to cash flow generated by selling or buying assets. These assets can include physical property, such as vehicles, specialized tools, or real estate properties, and non-physical property, like a patent. It’s worth noting that these purchases must be made with available funds and not through debt.

Financing activities record cash flow coming from equity financing or debt.

The critical term to understand here is “cash flow.” Some people can mistake cash flow for profit, but they don’t mean the same thing. A company’s profit is the difference between the company’s revenue and expenses. On the other hand, cash flow refers to the money that comes into your business and goes out of it. 

A cash flow statement uses that money flow to describe company activities. It can inform the business owner about particular activities that are incredibly profitable based on how much cash they generate. However, having a positive cash flow doesn’t always equate to profitability. This paradox can be understood better when you compare a cash flow statement to other financial statements.

Annual Report

Large public companies publish annual reports to their shareholders to keep them informed about critical financial and operational conditions. They usually create them with a touch of storytelling, including images and infographics, as well as written copy describing the company’s achievements, benchmarks, and activities. An annual report aims to provide a detailed insight into the primary goals of a business and its mission.

When it comes to the information contained within this document, a company presents its financial data with all of the other statements. These include the cash flow, income statements, and balance sheet. 

Public companies in the U.S. are also required to provide a 10-K report. This report describes various details about the company’s financial state, including operations, market activity, corporate agreements, fiscal activity, opportunities, and potential risks.

Determine Your Company’s Direction With Financial Statements 

Financial statements contain all the information you need to make reliable future projections and well-informed decisions. 

Although the various reports might seem complex to grasp at first, they’ll become relatively straightforward to read with some practice. Understanding your financial statements is well worth the effort. With all of the relevant information available, you’ll be able to make the necessary adjustments to keep your business moving forward.

Business owners who don’t learn about these statements might struggle to determine if their companies are making a profit. Once you learn how to read the essential financial statements, you’ll know how to plan for future growth and maintain your operations at an optimal level.

However, you’ll need access to proper reporting software to do all of this, and Swyft Books might be just the solution you need. If you’d like to see our service in action, don’t hesitate to sign up for a free trial today.