Doing business without a solid understanding of relevant accounting information is like going on a new trip without a map: It’s not a good idea. Financial statements provide a road map of a business’s journey by distilling the accounting information needed to make an informed decision. However, just as a topographic map will not be very useful to someone planning a cross-country road trip, you need to have the right financial statement for the job at hand.
Income Statement
The income statement is a method of cutting to the chase and presenting accounting information in a way that highlights how profitable a business is or isn’t. This financial statement lists income and expenses chronologically and indicates how much profit a business will generate once expenses are deducted over a set period of time. While this mode of presenting accounting information provides valuable data, the Small Business Administration warns that it can gloss over serious shortcomings in a business, such as insufficient cash flow.
Balance Sheet
Balance sheets provide business analysts with a snapshot view of a company’s financial health. They offer detailed information on the assets, liabilities and net worth of a business at any one time. Assets include anything a business owns or is owed, such as cash, inventory and payments owed by clients. Liabilities include all current financial obligations of the company, including debt, expenses and accounts payable. A single balance sheet of a company may raise more questions than answers, but a study of the changes in balance sheets from one day to another reveals valuable information on the company’s financial future.
Cash Flow Statement
As with most things in life, timing is crucial in business. It is of little use to know you can sell your product at a huge profit if you don’t have the cash to replenish your inventory. Cash flow statements allow you to keep tabs on whether a company is generating cash and how much. In that sense it provides similar information to an income statement. The difference is that cash flow statements provide information on a transaction-to-transaction time frame, which allows you to see precisely how much cash a business makes, not only its overall profitability.
Shareholder Equity
A shareholders’ equity statement records similar information to a balance sheet but reorganizes the accounting information to show the net worth of the company to shareholders. This is done by deducting the liabilities of a business from its assets. The result represents the company’s owners’ share in the financing of the business’s assets. A careful study of a company’s shareholders’ equity statement allows you to assess the profitability of a business to its owners in relation to the money they have invested in it.