How reviewing your business financial statements pays off
Reveal the truth about your business in three basic financial statements
Have you ever wished you could know exactly how profitable your company was last month or if your cash flow is adequate to pay off a loan more quickly?
Gone is the guesswork of yesterday with accounting software such as QuickBooks™ which allows you to access your company’s financial statements whenever you wish.
Contact the accounting professionals with a passion for small enterprise for a free, no-obligation consultation to learn more about using accurate financials to grow your business.
Should I be using cash or accrual statements?
Many private companies use the cash basis for developing financial statements. With the cash basis, income is recognized when the cash is received and expense is recognized when it is paid. Cash basis is easy since it relates to the check book. Yet, cash basis has serious weaknesses. The key weakness is failure to incorporate accounts receivable or accounts payable into the financial statements, as is done in the accrual method of accounting. Too often the checking account looks good only because the bill have not been paid. For this reason we strongly encourage accrual accounting for business financial statements.
1. Income Statement
The Income Statement, also known as the Profit and Loss Statement (P&L), shows the profit or loss a company earned over a specific operating period (see attachment for example). This period is typically monthly, quarterly, or annually. The P&L begins by showing total Revenue or sales less any sales discounts given. Cost of Goods Sold is then deducted from revenues to reach the Gross Profit Margins. Gross margins should be monitored carefully as they indicate how well a company is pricing their products as well as the costs to create those products. Many service firms do not use Cost of Goods Sold if their sole input for the product is labor.
Operating Expenses consist of fixed and variable expenses including sales, general, and administrative, and depreciation and amortization. Since operating expenses support operations and are not linked directly to a product, they are not included in the Cost of Goods Sold. As operating expenses do not necessarily increase the overall revenues but rather take away from the company’s profits, they should be monitored closely. Operating Expenses are deducted from the Gross Margins and the difference is Net Income (or Loss) before taxes. When taxes are removed, we arrive at our Net Income or Loss, also known as the “bottom line.”
Maintaining an accurate and transparent income statement is particularly important for travel agencies and other service industry businesses. We offer specialized bookkeeping services for travel agents, restaurants and bars, salons, and many other types of businesses.
2. Balance Sheet
Unlike the Income Statement, the Balance Sheet provides an overall view of the financial position of a company for a specific point in time. The Balance Sheet is often referred to as the “snap shot” of the business financial condition. The Balance Sheet includes Assets, Liabilities, and Owners Equity.
- Assets are listed in order of liquidity –first the Current Assets (cash and equivalents that can be converted into cash within twelve months) and then Long-Term Assets (Plant & Equipment, Land & Buildings, Intangible Assets, etc.).
- Liabilities are listed in the same order by commitments due. Current liabilities include those that need to be repaid within twelve months such as Accounts Payable, short-term loans, and accrued liabilities. Long-term liabilities include mortgages or other long-term loans.
- Equity in most small companies consists of individuals or partners. Profits are either paid as dividends to the owners or accumulated as Retained Earnings to be reinvested in the
- Total Liabilities plus Owner’s Equity must equal Total Assets in order for this financial statement to be in balance.
The information provided on the Balance Sheet allows management to ensure the proper cash levels are maintained and excess cash is invested in short-term investments. Accounts Receivable should also be monitored so that the cash flow of the business continues in a regular manner. Inventory levels need to be watched so that additional carrying costs are not incurred from a surplus. Accounts Payable should be observed so that bills are paid within the terms and that enough liquidity is maintained in the company to permit this.
3. Cash Flow Statement
While the use of accrual accounting allows a company to accurately view income and expenses in the same period on the Income Statement, it does not show the flow of cash entering and exiting the company. This is the role of the Cash Flow Statement for a given period of time. It also shows the sources of cash.
Cash Flow Statements are divided into three parts:
- Cash from Operating Activities
- Cash from Investing Activities
- Cash from Financing Activities
The Cash Flow Statement begins with the Net Income or Loss of the company and then adds or deducts non-cash operating activities. For example, depreciation is added back since no cash is utilized to pay depreciation expenses. Adjustments are also made to reflect changes in inventory, Accounts Receivable, and Accounts Payable.
Cash from Investing Activities usually includes capital expenditure activity such as a merger with another company or the purchase of long-term assets such as equipment. The sale of equipment or a portion of the investment portfolio would also be reflected here. Cash from Financing Activities includes the sale and purchase of stock in public companies, but also the payment of dividends and the incurrence and payment of debt.
Basic Financial Analysis
Three years of financial data are typically reviewed in order to uncover trends and seasonality issues. Monthly review should include a comparison to budget as well as year on year examination. While the current monthly review might reveal that the company did not meet the projected budget for revenues or profits, a year on year comparison could still show positive growth. This simply shows that the stretch in budget was not reached and a management could have a conversation around alternative ways to increase revenues or profits. It is important that year on year financial statements reveal continued, steady growth in the company.
The discipline of regular review of the financial statements will encourage consistent company growth. This review also enables management to make adjustments as needed and compare the business relative to company goals and industry benchmarks.
Bookkeeping & Accounting Professionals Serving Milwaukee Small Business Owners
Financial statements should be reviewed by management minimally on a monthly basis in order for timely decisions to be made regarding the business. Quarterly or year-end statements do not allow management to correct the course quickly enough during the year. We believe that timely accurate financial information is a foundation for business management.
Failure to maintain accurate accounting records can have serious financial and legal consequences, inhibit growth and even cause a business to fold. Professional bookkeeping ensures timely and accurate financial information, giving your small business a greater chance of success.
Contact our Milwaukee bookkeeping firm for a free consultation to learn more about making basic financial statements work for you.