A Guide to Reading Financial Statements for Small Business Owners
by Brooklynn Chandler Willy | May 8, 2023 | Brooklynn Chandler Willy, Entrepreneurship
Although you may be familiar with the various nancial statements that are presented to a business owner, you may need help to interpret them correctly. This guide will provide you with the necessary information to make informed decisions. Financial statements are composed of various components such as the income statement, cash ow statement, and balance sheet.
The Income Statement
An income statement shows a company’s income, expenses, and net income for a speci c period. It’s important to note that the amount of money the business makes and spends during a speci c period is shown. When reading an income statement, look at the revenue or sales section. This will show how much your business makes from selling products or services. Next, look at the cost of goods sold section, which shows the expenses directly related to producing the products or services sold. The di erence of revenue and cost of goods sold is the gross pro t.
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After gross pro t, the income statement will show operating expenses. These expenses can include rent, utilities, salaries, and marketing expenses. The di erence between gross pro t and operating expenses is the operating income or loss. Lastly, the income statement will show non-operating income and expenses, such as interest income and taxes, ultimately leading to the net income or loss for the period.
The Balance Sheet
The balance sheet provides a snapshot of a business’s nancial position at a certain point in time. It shows what your company owns, owes, and what is left over for the owners or shareholders.
When reading a balance sheet, start with the assets section, which shows what your business owns, such as cash, accounts receivable, inventory, and equipment. Next, look at the liabilities section, which shows what your business owes, such as loans, accounts payable, and taxes owed. The equity section shows the di erence between assets and liabilities, which shows what is left over for the owners or shareholders.
The equity section is further broken down into two parts: contributed capital, the money invested by the owners or shareholders, and retained earnings, which is the money earned and reinvested by the business.
The Cash Flow Statement
In ows and cash out ows for a particular time are documented in a cash ow statement. The speci c time re ected in a cash ow statement is typically a month, quarter, or year. It shows how much cash your business generated from operations, investing, and nancing activities.
When reading a cash ow statement, start with the operating activities section. This section will outline the cash in ows and out ows related to the day-to-day operations of your business. Next, look at the investing activities section, which shows the cash in ows and out ows associated with buying and selling assets, such as equipment or real estate. Lastly, look at the nancing activities section, which shows the cash in ows and out ows in conjunction with borrowing or repaying loans, issuing or buying back shares, and paying dividends.
Tips for Reading Financial Statements
1. Look for trends over time. By comparing nancial statements from di erent periods, you can see how your business performs and identify improvement areas.
2. Pay attention to ratios. Ratios, such as the debt-to-equity ratio and the gross pro t margin, can provide valuable insights into the nancial health of your business.
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3. Feel free to ask for help. If you need help reading or interpreting nancial statements, consider hiring a nancial professional or consulting with a mentor or advisor.
Understanding how to read and interpret nancial statements is essential for small business owners. By understanding the income statement, balance sheet, and cash ow statement, you can gain valuable insights into the nancial health of your business and make informed decisions about its future. It’s essential to look for trends over time, pay attention to ratios, and seek help when needed. Remember that nancial statements are just one tool in your nancial management toolbox and should be used with other nancial management strategies, such as budgeting and forecasting.
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