If you want a clear understand of how your business is doing financially, and
you want to be able to predict and plan for the future, a fairly thorough
understanding of your financial statements is essential. A sound understanding
of financial statements will help you:
- Identify unfavorable trends and tendencies in your business's operations
(for example, the unhealthy buildup of inventory or accounts receivable)
before the situation becomes critical.
- Monitor your cash flow requirements on a timely basis, and identify
financing needs early.
- Monitor important indicators of financial health (for example, liquidity
ratios, and solvency
- Monitor periodic increases and decreases in wealth (specifically, owners'
or stockholders' equity).
- Monitor your performance against your financial plan, if you have
There are four basic kinds of financial statements that can help you
determine the present condition of your business. Here's a brief description
income statement, also referred to as a "profit and loss
statement," "statement of incomes and losses," or
"report of earnings," tells you or your investors:
- the income the business has earned during the accounting period
- the costs or expenses that were incurred by the business during the
- the difference between the costs and incomes for the period, or net
profit (or loss)
balance sheet is a statement of a company's relative wealth or financial
position at a given point in time. It shows assets, liabilities, and owners'
position statement, also known as the "statement of changes in
financial position" or "sources and uses of cash," helps to
explain how a company acquired its money and how it was spent.
statement of changes in owners' equity is used to bridge the gap between
the amount of owners' equity at the beginning of the period and the amount
of their equity at the end of the period.
to do with your financial statements contains a checklist of ways to
look at the data to put it in perspective.
size financial statements provides an easy way to spot trends in your
balance sheets and income statements over time is to convert the dollar
amounts to percentages.
Limitations of financial statements. Keep in mind that your financial
statements are only a starting point for analysis. Individual numbers aren't
good or bad in themselves — you may have to dig for the reason behind any
numbers that seem out of whack. For instance, if your statements shows that your
accounts receivable have trended significantly downward over the last few years,
it could mean that you're collecting the accounts more aggressively (which is
good), or it could mean that you're writing off accounts as uncollectible too
soon (which is bad). The key is to use your statements to spot trends and
anomalies, and then follow these up with further investigation.