As a business owner, financial data is critical to your success — but only if you know how to interpret the meaning behind the numbers correctly. Most owners or leaders within an organization rely on the aid of an accounting team to accurately analyze and organize financial data. Still, when it comes time to make a big decision, it’s up to you to do so based on the gathered information.
There are at least three primary financial statements your accounting team will (read: most definitely should) be presenting to you regularly: income statements, balance sheets, and statements of cash flow.
With a solid understanding of each financial statement, you can unlock powerful insights to help you compete more effectively in the marketplace, achieve better terms from vendors and suppliers, and offer accurate projections to both internal stakeholders and lending companies alike.
The income statement (also called a profit and loss statement or P&L statement) measures the profitability of your business during a specified accounting period. This statement assesses all of your business’ revenue and expenses, and then reports a net profit or net loss.
By industry standards, this is the most influential of the three significant statements. This report shows where the money is allocated and breaks down business costs into categories.
Importantly notated are costs directly related to goods and services. It also calculates your company’s earnings from multiple viewpoints, reporting not only the net earnings (your bottom line) but also an assessment of the business’ productive efficiency before the impact of taxes and financing.
Read More: Understanding Your Financial Statements
It’s helpful to compare multiple income statements from different accounting periods to monitor whether your business is becoming more or less profitable over time — allowing you to adjust your spending and production processes accordingly.
The information on the balance sheet is monumentally more valuable when viewed in conjunction with your income statement. For instance, you can use the data from the balance sheet to determine how many investments are required to support the bottom line shown on your income statement.
While the income statement focuses on one specific accounting period, the balance sheet shows a snapshot of your overall financial health on a particular day by using a simple equation: liabilities + equity = assets.
These factors give you an idea of what the business owns (assets), what it owes (liabilities, including short-term expenses and long-term debt), and how much capital shareholders have invested (equity). As the name suggests, the two sides of the equation in your balance sheet should balance out.
Read More: Financial Tips From Successful Leaders
Statement of Cash Flows
The cash flow statement does just what the name implies — it reports on the flow of cash into and out of your business. Unlike the income statement, which breaks down earnings and expenses into more specific categories, the statement of cash flows focuses on the overall amount of money coming in (inflow), compared to the amount of money going out (outflow).
To find this data, it takes precise calculations using the following equation: starting cash balance + cash inflows – cash outflows = ending cash balance.
Cash inflows include sales, loans, and accounts receivable collections. Alternatively, cash outflows include equipment costs, inventory, and expenses paid. The statement of cash flows presents the most transparent view of a company’s cash variation. In other words, what caused the balance in your bank account to increase or decrease.
Even Harvard Business School agrees that the number one finance skill a leader needs is an understanding of their financial statements and you can’t argue with Harvard right?
Once you have an understanding of these top three financial reports, we encourage you to have your accounting team run the Accounts Receivable and Accounts Payable, as well as Net Profit Margin Over Time.
Comprehensive knowledge of the financial side of your company will be incredibly helpful when it comes to making smart business decisions.
If your accounting team needs help or are not sure how to gather the information for these reports, have them contact us. Our expert team of accountants and business advisors are here for help in situations just like these.