Who Uses Financial Statements? and why…
The idea having financial statements for a business may be a new concept for some. I’ve have plenty of clients who’ve started their businesses without them. They simply draw down funds from the accounts and start their business. If they can do it, why not everyone? It then becomes the question: who uses financials statements? Before I answer that question, let’s start off by talking about what exactly is a financial statement.
Breaking down the Financial Statement
Balance Sheet – In a nutshell, the balance sheet gives a snapshot of a business’s assets, liabilities, and equity. In an earlier post, I talked about the balance sheet in more detail. I encourage you to check it out, as it includes a template you’re free to use.
Income Statement – I always think the name income sheet is misleading, because it makes it sound like it’s all about revenue. In actuality, an income sheet relates to profits and losses. That is, it tracks the income, EXPENSES, AND PROFITS of a business over a period of time.
Equity Statement – This section refers to the company’s equity or retained earnings. Like the income statement, it covers a specified period of time. Whereas you’d find a summary of the retained earnings on a balance sheet. In the equity statement, you’d find the retained earnings laid out by line items.
Cash Flow Statement – Cash flow statements are one of my favorite parts of financial statements. In this section, you’ll be able to see how a company’s financials ebb and flow based upon its operating, investing, and financing activities.
Financial Analysis Simplified
So, what does all this tell you about the state of a company’s financial health? Typically, if your balance sheet looks good, you’re company is doing well overall. The Income statement also shows the health of a company. However, it only shows the health of the given period of time identified on the income statement. If we flip things and talk about unprofitable balance sheets and income statements it’d be more on the lines of: If you have an unprofitable income statement 12 months, you’ve just had a bad year. On the other hand, if you have an unprofitable balance sheet, you have an unprofitable business over all.
I find retained earnings rather interesting, as the negative or positive balance rolls over from one year to the next. For instance, if your retained earnings are $50,000 in one year and the next year your net earnings is $30,000, your new retained earnings would be $80,000. If the next year, you have a net loss of $20,000, you’re new retained earnings would be $60,000. What makes retained earnings so important is it refers to how much capital a business has to invest in other areas, such as research and development, equipment, training, or other aspects that might enhance the profitability of an organization.
So! Now that we understand what exactly is a financial statement, let’s talk about who cares about them.
Investors/Bankers – The piggy banks
First of all, investors (and I’m including bankers in that category) care about your financial statements, because they want to know your company is in good health before they give money to you. Investors don’t give you money out of the goodness of their hearts. They give you money because they plan to make a return on their investment ROI. If your company isn’t in good shape, the chances of them getting an ROI is risky. Smart investors and Bankers understand every venture has a risk. However, they keep their risks in acceptable levels — calculate their risks.
Government Contracting – Sucking up to Uncle Sam
I mentioned minority owned businesses in another post being able to qualify for economically disadvantaged designations. Your financial statements will come into play in this situation. If you’re looking for more details in government contracting and disadvantaged businesses, I encourage you to check out that post.
Business Owners – It’s all about you
Last, but not least, YOU need to understand the financial health of your business. I often create financial projections for business owners. However, I often have misgivings about doing so. Why? because business owners miss out on the opportunity to gain understanding through development of their financial statements, and it’s important for business owners to understand how their business is doing so they can make adjustments as needed. Staying up to date on your financials can save you a significant amount of money, as you’ll be aware of adverse conditions earlier than later and can act accordingly.
How much involvement do you have in creating your financial statements?