Decoding Financial Forms: Unveiling the Secrets of Balance Sheets, Income Statements, and Cash Flow Reports

 

"The financial statements are the tools that will help the entrepreneur track progress and wealth created by the business."

Understanding financial statements is crucial for entrepreneurs and business owners seeking to monitor and grow a successful company. The three essential financial documents - balance sheets, income statements, and cash flow reports - provide vital insights that can unveil opportunities, identify potential issues, and guide critical business decisions.

In this blog post, we’ll decode the three essential financial forms - balance sheets, income statements, and cash flow reports - and reveal what information these documents contain.

The Purpose of Financial Statements

Financial statements provide quantitative information about a company's financial health and performance. By regularly reviewing these documents, entrepreneurs can monitor profits and losses, adapt business plans if needed, and communicate clearly with shareholders. As intimidating as these forms may seem at first glance, learning a bit about what each one conveys can unveil many business insights.  

Balance Sheets - A Snapshot of Assets, Liabilities and Equity

A balance sheet is a financial statement that summarizes a company’s assets, liabilities, and shareholders’ equity at a specific point in time. Just like a personal net worth statement, the balance sheet provides entrepreneurs with a snapshot of their business’s financial standing. There are three sections that comprise a standard balance sheet:

Assets - This section lists everything the company owns that holds financial value, including:

•           Cash and cash equivalents

•           Accounts receivable 

•           Inventory

•           Property, plants and equipment

•           Intangible assets like patents or trademarks

Liabilities - This sums up all the money that the company owes to outside parties, such as:

•           Accounts payable

•           Short and long-term debt

•           Taxes owed

Shareholders’ Equity - Also referred to as “net assets,” this represents the amount left if all assets were liquidated and liabilities paid off. It includes:

•           Paid-in capital from investors

•           Retained earnings

A balance sheet must always balance, meaning the combined value of assets and liabilities/equity must be equal. Comparing balance sheets over time helps assess the company’s improving or declining financial fortitude.

Income Statements - Tracking Revenues and Expenses  

While a balance sheet shows a business’s financial status at a point in time, an income statement summarizes financial performance over a period of time - typically per fiscal quarter or year. Also called a “profit and loss statement” or P&L, the income statement tracks all revenues earned and expenses incurred during the specified timeframe. By comparing total revenues and expenses, the income statement calculates a company’s net profit or net loss. 

There are several key line items on the income statement:

• Revenues - This encompasses all sales and income generated during the period.  
• Costs of Goods Sold (COGS) - Direct production costs for creating products/services.  
• Gross Profit - Revenue minus COGS. This number represents financial resources available for operating expenses and profit.
• Operating Expenses - Day-to-day costs for sales, administration, and other business operations.  
• EBITDA - “Earnings Before Interest, Taxes, Depreciation, and Amortization” tallies earnings after operating expenses are deducted. This metric shows the profitability of the company’s core business.
• Net Income - The “bottom line” calculates total profit or loss after additional expenses like interest, taxes, and depreciation. Also called net earnings or net profit.

Just like the heart rate monitors a patient’s health, monitoring income changes, every quarter provides entrepreneurs with an indispensable checkup on business performance.

Cash Flow Statements - Following the Money Trail

While income statements evaluate profitability, cash flow statements track the actual flow of cash going in and out. This statement adds another layer of insight by showing how money moves through the business’s core operations, investment activities, and financing activities. The cash flow report calculates period changes in:

• Cash from Operations - This tracks the net amount of cash generated from regular business operations, like sales and expense payments. It provides a clear picture of operating liquidity.  
• Cash from Investing- Shows cash used for or provided by investments, like purchasing equipment. 
• Cash from Financing - Includes cash activities related to business financing, like receiving loans.
• By detailing adjustments to cash balances each period, entrepreneurs can use cash flow analysis to assess if the business has the healthy cash flow required for growth.

The Entrepreneur's Compass    

In The Entrepreneur’s Guide, Rudolf Schmid rightly directs that financial statements “provide guidance and direction to entrepreneurs, keeping them on course in building their business.” Just like a GPS map or compass, balance sheets, income statements, and cash flow reports help entrepreneurs navigate the path to profitability and success. While deciphering these financial forms takes some dedicated learning, putting in the effort provides incredible guidance at every step of the entrepreneurial journey.

Grab your copy of The Entrepreneur’s Guide today!