Financial statements are the report cards of a company’s financial health. Understanding these statements is crucial for a company’s ability to take a business loan, funds, or any economical partnership with others. Those who consider these as just mere paperwork miss out on the insights provided in these statements which help in the improvement of business and keep it afloat. Financial statements keep track of a business’s money i.e., the source of the funds, where have they been used and their current status.
Advantages of Analysing Financial Statements:
- Helps the business determine its current cash status i.e., if it is improving or worsening.
- Comparison of business profits with other companies in the market.
- Helps in determining when the costs are going overboard as compared to revenues. This provides a chance to negotiate prices with suppliers and increase the efficiency of production.
- Assists in identifying the negative cash flow from operations and correcting the hidden problems in the business.
There are four important financial statements with any company namely: balance sheet, income statements, and cash flow statements.
- Balance Sheets
The balance sheet provides a glimpse of the company’s net worth. It is shown on the basis of what the company owns and what it owes. A balance sheet helps in knowing the worth of the company over a period of time and also determines its ability to pay back business loans and expenses.
The equation on which the balance sheet is set up is: Assets must be equal to the sum of the company’s liabilities plus shareholders’ equity.
- Assets: Assets are valuable things that a company owns whether tangible or intangible. For example, patents, trademarks, inventory, cash, investments, account receivables, equipment, real estate etc.
Assets are organised on the basis of their liquidity: –
(1) Current Assets are the assets that can provide liquidity within a year
(2) Non-Current Assets that can be converted into liquid cash in a period of over one year
(3) Fixed assets like property and equipment are used to operate the business, these are not for sale
- Liabilities: These are the obligations owed by the company to others in form of rents, loans, payroll and obligation to provide goods in future to customers.
Liabilities are organised based on their due dates:-
(1) Current liability is the one that expects payoffs within a year.
(2) Long-term Liability expects a payoff in the period of over a year.
- Income statements
It is also called the “profit and loss statement”. These report how much a company has gained and spent over a period of time. If the revenues are more than the expenses then there is net profit and if vice versa it is then net loss. Income statements measure changes in profits, profit margins and sales revenue over a fixed period like one fiscal quarter or year.
These statements consider income earned (not received) and expenses incurred (not paid). One needs to all about a business’s incomes and gains along with expenses and losses.
- Cash Flow Statements (the Statement of Cash flows)
These statements show the funds collected and used over a period of time in the following areas:
- Finances – cash flow related to raising and repaying share capital, debts, interest and dividends.
- Investment – Cash flow from buying and selling assets other than inventory
- Operations – Cash flow from main business activities
These statements are a supplement to income statements as it considers only the cash actually received and paid in form of expenses.
- Shareholders’ Equity: It is the amount that is left over if the business was sell all of its assets and pays off debts and that makes the current value of the business. The same is also called the capital or net worth of the company. Negative equity makes it harder to secure a business loan but positive equity can help you through stocks, dividends or equity.
The following are included in Shareholders’ equity:
(1) Initial investments are the opening balance of equity
(2) Common and preferred stock issued are the capital stocks
(3) Part of the revenues generated used by the sole proprietor is the owner’s draw
(4) Profits paid to shareholders in form of dividends
(5) Retained earnings are the sum of a business’s consecutive earnings
The financial statements are strictly reviewed before sanctioning any type of funding or business loans and for that matter, collaboration with other entities before entering into any fiscal contract. Thus, these statements must be kept up-to-date for healthy business opportunities.