by Michael Lodge
Over the last few months I have been writing blogs to explain how to read a financial statement and balance sheet. I want all small business owners to have a briefer description of what a income statement is and what a balance sheet does. I feel it is very important that business owners know how to read their financial statements and know how their business is performing. A financial statement can tell you how well you are doing and where you can cut some costs, or do better in a specific area of income.
By the way, it is October and it would be a good time for you and your tax accountant to sit down, review your financial statements, and do some quick tax planning for the remainder of the year. If you need help and would like to sit down with a tax practitioner, call our office at: 877.778.1770 Be proactive and think about the end of year taxes now.
Businesses produce a set of financial statements that reflect business activities, revenues and expenses for each accounting period. The three main financial statements are the balance sheet, income statement and statement of cash flows. The cash flow statement simply shows the company’s cash activities, the balance sheet illustrates a company’s book value, and the income statement shows how assets and liabilities are used.
The balance sheet shows the company’s assets, liabilities and shareholder equity. The basic accounting formula Assets = Liabilities + Shareholder Equity provides the structure for the statement. Assets are listed first in order of liquidity, including cash, short-term investments, accounts receivable, notes receivable, inventory and prepaid expenses. Next, long-term assets such as investments, fixed assets such as real property, other assets and intangible assets are listed. The sum of all assets should equal the following section of the balance sheet, which lists all liabilities in order of maturity and shareholders’ equity. Investors need all of this information to determine the current value of the company.
The income statement, like the balance sheet, helps to illustrate the current value of a business. Revenues and expenses are listed on the income statement as they are accrued and categorized as operating or nonoperating activities. First, sales are matched with cost of goods sold to determine gross profit. Next, operating expenses are deducted to reveal operating profit. From this point, any nonoperating revenues and expenses are listed, generating earnings before interest, taxes and amortization EBITA. Taxes are then deducted to reveal the net income. Shareholder distributions are typically made using this final sum, so investors watch it closely. Investors and analysts also pay close attention to the operating section of the income statement to gauge how efficiently management operates the main activities for the company.