The complete set of your business’s financial statements includes three reports. Each of these reports serves a different purpose, but they each assist stakeholders, including managers, investors, lenders, and employees, in evaluating a company’s performance. The following overview explains each report and the important questions they answer.
The income (or profit and loss) statement
The income statement helps stockholders to assess whether the business is growing and profitable.Your income statement will include the revenue, expenses, and earnings of your business over a given period.
One key term to know when discussing income statements is “gross profit”—gross profit is the income earned after the cost of goods sold is subtracted from revenue. The cost of labor, materials, and overhead required to create a product are all included in the cost of goods sold.
“Net income” is another important term to understand. A business’s net income is the income that remains after it has paid all of its expenses, including taxes.
Growth and profitability aren’t the only important metrics, though. Companies with healthy top and bottom lines can lack the on-hand cash to pay their bills, for example. Although revenue and profit trends might seem like the most important part of your business’s statement, you’ll want to pay serious attention to the other two reports.
The balance sheet
The balance sheet can help you assess what your company owns—and what it owes. Your balance sheet report provides a tally of your assets, liabilities, and “net worth,” and offers a basic overview of your company’s financial health.
Assets are reported on financial statements at the lower of cost or market value, under U.S. Generally Accepted Accounting Principles (GAAP).
Assets that can be reasonably expected to be converted to cash within the year (such as inventory or accounts receivable) are classified as “current assets.” “Long-term assets” have longer lives and include assets such as property and equipment.
Liabilities are classified in a similar way: payment obligations like accounts payable that come due within a year are “current liabilities,” while payment obligations extending beyond the current operating cycle or year are “long-term liabilities.”
Although intangible assets like goodwill, patents, and customer lists may provide your business with significant value, intangible assets only appear on the balance sheet when they’ve been acquired externally. Intangible assets that have been internally developed aren’t reported here.
The net worth, or owners’ equity, of a business is the value of the business’s assets once liabilities have been subtracted. This means that the net worth will be negative if the book value of liabilities is greater than the book value of the business’s assets.
However, book value may not always be reflective of market value. As such, some companies may include a separate statement called the statement of retained earnings, which provides the details of the owners’ equity and details dividend payments, sales or repurchases of stock, and changes caused by reported profits or losses.
The cash flow statement
The cash flow statement helps to clarify where a company’s cash is coming from and where it’s going to.
Cash flow statements show all of a business’s inflows and outflows. For example, your business may have inflows of cash from selling products or services, selling stock, or borrowing money, while its outflows may result from repaying debt, paying expenses, or investing in capital equipment.
Cash flows are usually organized in three separate categories for operating, investing, and financing activities, and the net change in cash during the period is usually displayed at the bottom of the statement.
Companies need to continually generate cash in order to pay vendors, creditors, and employees, so it’s important to pay close attention to your statement of cash flows.
Don’t ignore disclosures
Disclosures provide additional details at the end of a business’s financial statements. Disclosures are qualitative descriptions that can help your business make well-informed decisions in conjunction with the three qualitative reports discussed above.
If you need help benchmarking financial performance and conducting due diligence, contact us.