Do you know how to read financial statements? If not, it’s something that you absolutely should learn how to do as a business owner. By knowing how to read a financial statement, you can make sure that the path you’re guiding your company down is the right one. This is especially important in the formative years of a company, when operating budgets are tight and reputations haven’t been fully established yet.
Among the many documents that you’ll maintain as a business owner, I would argue that your financial statements are the most important for a number of reasons that I’ll outline in this post. So if you want to learn how to read financial statements, now’s your chance to learn more.
Financial Statement Analysis 101
Before we get started on learning all about how to read financial statements, let’s go with a basic explanation of just what one is.
In the simplest terms, a financial statement is a written report that shows the overall financial health of your company.
This report is actually made up of four different reports, so you can think of your financial statement as something of a compilation.
That said, the four reports that make up your company’s financial statement include:
- The Income Statement – Sometimes you may hear it referred to by this name. Other times you may hear it referred to as the Profit & Loss Statement (P&L).
Either way, this is a report that tells how much money (profit) your company makes over a given period of time. As the business owner, you want to know when how your business is performing (profitable or losing money) and this aspect of the financial statement makes it happen.
Going over the P&L is to your advantage because it gives you a glimpse into what your company’s strengths and weaknesses are as you carry out business operations.
- The Balance Sheet – This is also known as the “statement of financial position” and is a record of your company’s financial condition at a given point in time.
It consists of information that tracks assets, things that you own, and your liabilities, things that you owe.
For the former category, think about things like cash, inventory, and patents. For the latter; consider bills, payroll, and money owed to investors and you’ll have a rough idea of the information tracked on your balance sheet.
Going over this part of your report is important to knowing how to read financial statements because being exactly what you have on hand is crucial to running a business that functions effectively.
- The Cash Flow Statement – Staying up to date on matters related to areas like operations, investments, and financing is extremely important in the business world because these things all affect how much cash you’ll eventually see on the balance sheet that you just learned about.
When talking about the cash flow statement as far as how to read financial statements is concerned, you’ll be able to keep track of crucial metrics and areas like depreciation, accounts receivable, and other important areas of core operation. Also, you will be able to determine if your business is throwing off more cash than it needs or if it requires additional capital investment.
How your company generates its cash is important, so the cash flow statement carries a lot of weight in your overall financial statement.
- The Statement of Changes in Equity – As the business owner, you have equity in the company, so knowing how to read financial statements naturally involves this report, which shows how that equity shifts over a given period of time.
Due to a variety of factors, your financial interest in the company can go up or down and the statement of changes in equity gives an overview of that trend.
With the right kind of guidance, your business is going to grow and change with time, and you want to be able to grow with it. Having this as part of your financial statement will show where you stand in the grand scheme of things.
Making Sense of It All
Of the many things that I talk about, the importance of how to read financial statements is something that can’t be stressed enough. Not knowing how to make sense of the reports that are included in one is a huge mistake that no entrepreneur should make, so I want you to comb over your financial reports as carefully as possible.
Doing so will not only give you an idea of how things are going, but it will show you where resources can go and give you important information about what you can do to ensure that your organization continues to be a success.
Remember, running a business successfully does not need to be complicated. Keep it simple!
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Manny Skevofilax is a consultant and speaker that helps his clients successfully navigate the challenges of growing their businesses profitably. Since 2003, Manny helps businesses enhance their results by using his experience in strategic planning, financial statement analysis, operations, organizational development, and team-building. His consulting firm, PORTAL CFO Consulting, Inc., has attracted clients from diverse industries in the United States and abroad.
Manny can be reached at 410-808-3441 or via email at firstname.lastname@example.org.