Regardless of your business’ size or the industry in which it operates, there are several financial statements you need to complete and update on a regular basis.
These financial statements will comprise a main part of your business plan, and that business plan will play an integral role in securing the investments or loans needed to grow your company. Financial statements will also help you understand how money flows into and out of your business, which leads to smarter decisions around which investments to make, which loans to pursue and more.
What Is a Financial Statement?
Financial statements provide a formal record of an organization’s financial activity, its current financial status and an idea of how well it may (or, may not) perform in the future. Financial statements can help to show business activity and financial performance. They are required for audits and are often used for tax, financing or investing purposes.
Financial statements are broken down into three main items: a current balance sheet, a profit and loss (P&L) statement, and a cash flow statement. Together, they provide an understanding of profits and a basis on which to make predictions about the company’s financial future. Here’s a look at each and the purpose it serves:
- The balance sheet shows assets and liabilities.
- The P&L statement, or income statement, records company revenues and expenses for a particular period.
- The cash flow statement demonstrates how much cash a company has on hand and its ability to manage its cash, as well its ability to meet current liabilities, pay operating expenses and fund any potential investments.
- Financial statements are an important part of running a profitable, financially-sound business.
- Financial statements comprise three individual items, all of which help both internal and external stakeholders make good decisions regarding the company.
- A financial plan is equally as important, and helps business owners chart their courses for the future based on their current and historical financial positions, resources and contingency plans.
Why Is a Financial Statement Important?
Financial statements(opens in new tab) include all of a small business’s operational results, its current financial position and its current cash flow. Financial statements are important because:
- They create a documented “paper trail” for a company’s financial activities.
- They summarize important financial accounting information about the company.
- They give both internal and external stakeholders an accurate picture of the organization’s current financial situation.
Financial statements are also used by lenders to determine an entity’s level of risk. These statements also include information that may be required by law and/or accounting standards. They also provide accountants with the data they need to be able to complete a company’s tax returns and other required documentation.
Individually, the three main financial statements for small businesses each serve a different purpose. The income statement, for example, shows whether a company is generating a profit, while the balance sheet reveals the current status of the business as of the date listed on that document (vs. for the year or quarter overall, as with the income statement). Finally, a company’s cash receipts and cash disbursements can be found on its cash flow statement.
Video: Understanding Financial Statements
What Should Be Included in a Financial Statement?
Business owners and their accountants use income statements, balance sheets and cash flow statements to analyze a company’s financial performance.
The income statement(opens in new tab) includes all of a company’s revenues, cost of goods (or cost of sales for services companies) sold and other expenses across a specified time period (e.g., a quarter or a year). Listed vertically, the entries on this statement typically appear in this order: revenue, expenses, and net income
The balance sheet includes all of a company’s assets, liabilities and shareholder equity. In most instances, these numbers are represented in two different columns.
Finally, the cash flow statement summarizes all of a company’s operating, financing and investment inflows and outflows, including but not limited to changes in the value of inventory, accounts receivable and payable and long-term debt.
How Do I Write a Financial Plan for my Business?
You can create a financial plan whether you’re just launching your business, preparing to expand it in some way or readying to pursue a new source of funding. Using the financial statements outlined in this article, you’ll create a financial plan that not only covers the organization’s progress and current status but also factors in future growth. This is an exercise you can do for yourself, potential investors including venture capitalists, or any other business stakeholder.
At minimum, the plan should include a sales forecast for the next three to four years, a budget for business expenses and overhead, a cash flow statement and a projection of anticipated net profits over time. The plan should also factor in the company’s assets and liabilities, an estimate of cash on-hand (and expected cash on-hand over the next few months) and current accounts payable.
Combined, these key data points will help you chart a course for the future by 1) assessing the company’s current financial status and 2) predicting a path forward based on historical performance. The plan will help you manage cash flow, prepare for potential cash shortages (e.g., due to industry or economic downturns) and set attainable goals for the next three to five years.
By putting a plan together and then reviewing and updating it annually, companies can readily pursue new opportunities, ride out the low points and achieve their short- and long-term goals.
5 Steps to Writing a Financial Plan for my Business
Here are the five steps you’ll want to take when writing a financial plan for your company:
Lay out your goals. Do you want to expand? Do you want to add new customer segments? Do you need more equipment? Do you need financing? The answers to these questions will help you kick off the financial plan writing process.
Create monthly financial projections. Small businesses don’t typically have the kind of reserves or business footprint to plan too far ahead. They need monthly projections. Calculate your anticipated income based(opens in new tab) on monthly projections for sales and expenses for items like labor, supplies and overhead, and then add in the costs for the goals you identified in the previous step.
Prepare a cash flow statement, income statement and balance sheet. Use these financial statements to create an accurate, current picture of your company’s financial health.
Calculate your business ratios. Used to rate the overall financial health of a small firm and decide whether its current operating model is viable, financial ratios are a key factor in assessing a company's basic financial health. In most cases, you will use either the current ratio or quick ratio.
Current ratio =
Current assets / Current liabilities
Quick ratio =
(Cash + Cash equivalents + Current Accounts Receivable) / Current liabilities
From these calculations, you can determine whether your company has the funds available to cover its short-term obligations.
Include contingency plans. You’ll want to have enough emergency sources of money before your business faces challenges that warrant using them. Maintain a cash reserve of three to six months, for example, or ensure that there’s money available on your line of credit. Like anything in life, the key is to not wait until it’s too late to secure these fund sources and ensure that they are there when you need them.