A financial statement is a clear written model of how your business is doing and what it’s expected to do in the future. It’s an important document for lenders to know the condition of your financial health. But more importantly than knowing what’s a financial statement by its definition, is to know how to analyze it and to track how your business is doing. Keeping reading more details below to find out how to define your financial statement, what it means to your business, and how to look at it properly.
What Is a Financial Statement?
A financial statement is a sample of how your business is functioning, daily operations, and your future business outlook. Financial statements provide information about business activity and performance and include three reports: the balance sheet, the profit and loss statement, and the cash flow statement.
Financial Balance Sheet
Your balance sheet consists of several different components of your business assets, how they're measured, and current/future debt. Most lenders or bankers, will take a close look at your balance sheet to determine if they want to extend you a loan. The loan provider wants a current snapshot of your business by requesting to see your balance sheet.
The left side (debit side) shows your company assets.
Assets are items with either present or future value, consisting of:
- Accounts receivable
The right side (credit side) shows how those company assets are funded.
Your assets can be funded by:
- Equity (residual claim or funding by the owner)
- Liabilities (accounts payable and services and items that must be delivered due to past transactions)
Your equity and liabilities are used to attract capital for your funding initiative. The balance sheet also identifies a company's long-term debt and documents a point in time for your financial history.
How Does The Accounting Equation Apply?
The accounting equation is used to calculate your business worth. The formula consists of: Assets = Liabilities + Equity
An example of the accounting equation:
Newly incorporated company DSXD Inc. offers landscaping services. For the following example, the accounting equation method is being used.
The firm is incorporated on the first of January 2010. The owner pays $40,000 cash for 10 shares.
Assets = Liability + Equity
40,000 = 0 + 40,000
It's important to document how your business is doing financially.
Profit and Loss Statement
The profit and loss statement is also known as your income statement. Since pertinent information lies on both sides of the balance sheet, the accounting equation implies that both your debits should be equal to your credits at all times. In fact, the accounting equation serves as a record of your business transactions.
Note: Assets are usually understated relative to the market value. However, liabilities are not (giving your equity understated value).
Cash Flow Statement
A lender has to know that your business can stay afloat if they lend you money, and the cash flow statement is the key to this information. Furthermore, your cash flow statement has three general points that include:
- Showing investors the cash flow going in and out of your business (i.e., financial position)
- Insight on how cash is being generated
- How much daily cash your business is making
A strong, cash flow statement will focus on the cash a business is receiving, investors, and financial activities. A healthy cash flow statement will show your business has money coming in, but a bad statement will show a negative operating cash flow, which is frequently a trend for start-up networks or very small companies.
Calculating Cash Flow From Your Financial Statement
Your cash flow is calculated by making adjustments to your net income by adding or subtracting differences in expenses, revenue, and credit transactions that are listed on your balance sheet. This is based on business transactions that carry from one period to the next, usually from the beginning of the year to the end.
Bottom line: The income statement shows where you've been, the balance sheet shows your current finances, and the cash flow statement shows if you have the money to prove you're operating successfully.
Ironically, many businesses fail to get the funding they need because they don't feel that a financial statement is necessary. A financial statement is a mandatory financial resource for your business. According to expert financial consultants, a business financial statement will one day serve a purpose. For example, if you get a lucrative offer to sell your business, a family member won the lottery and wants to invest in your business, or you found suppliers that will sell you equipment at a lower price, a financial statement will be needed.