How to Read a Financial Statement
Running a business is challenging enough without the added pressure of being in the dark about your company’s financial status.
Successfully operating and growing your business requires that you understand your company’s financial health. You can better avoid risks, identify, and seize growth opportunities for future success, and make strategic decisions that can lead to long-term prosperity.
Financial statements are essential tools for assessing and analyzing your business. Your financial statements will make clear how much revenue your business earns, how your company spends money, and how much debt it has incurred. However, taking in all the numbers can be hard when you’re not an accountant or financial expert.
We at Devine Consulting talk “financial speak,” but our clients and many other professionals do not. Since we believe in supporting construction companies and contractors, we have created this guide to help you better understand financial statements and how to use the information to build your business. You’ll gain insights and build confidence in your ability to assess and analyze your profits and losses.
Three Important Financial Statements You Should Understand
You need to understand your company’s financial strength using three financial statements: the balance sheet, income statement, and cash flow. They each provide valuable information on their own, but when analyzed together, they allow for an in-depth look at how strong or weak your business may be.
- Balance Sheet: This shows what your company owns and owes at one particular moment.
- Income Statement: This shows how much your company earned and spent over a specific period.
- Cash Flow Statement: This shows the sources of cash inflow and the areas of cash outflow.
They are each important individually and provide even more value when analyzed together. Your financial statements will show you where your company’s money comes from, where it goes, and where it stands now.
A Closer Look At Each Financial Statement and What They Reveal
The balance sheet will show the “balances” for each asset and liability account at a particular moment, typically at the end of a month. If your company is owed money from someone, this will show as a receivable, and if your company owes money to someone, this will show up as a liability. It will also list equity for any investors or shareholders.
Assets: Assets are items you own that have value. These include items your business can sell or use to manufacture products or provide services. Assets include property, equipment; inventory; trademarks; cash in the business bank account; investments, accounts receivable, and patents.
Liabilities: Money owed to your debtors. These debts could be short-term loans from a bank, money owed to vendors for supplies, contractors for work completed, payroll, and tax debts.
Equity: The owner’s equity is the net worth of your business; the amount left over is all assets you sold all assets and paid all liabilities. This amount belongs to your company’s owners or shareholders.
The amounts listed on the balance sheet are plugged into the accounting formula:
Assets = Liabilities + Shareholder’s Equity.
As the name of the financial statement indicates, both sides of this equation must balance. Your business’s assets must equal the sum of its liabilities and equity.
The Income Statement, also called the profit and loss statement, shows the company’s revenue for a specific year or quarter and all relevant expenses. It will show the influx of income into your business, quantify the expenditures to produce business revenue, and what is left over – your profit. As you read the income statement from top to bottom, you will see revenues, cost of revenue, overhead costs, and taxes.
The last line on the income statement is the total profit for the indicated period that your company has earned.
Information found on the Income Statement:
- Sales Revenue – The amount of money your business has earned.
- Cost of Goods Sold (COGS) – The costs of the materials and components to manufacture the products you sell
- Cost of Services – The cost to provide the services that your business sells
- Gross Profit – This is the total revenue minus your business’s COGS or Cost of services.
- Operating Expenses – Money spent to run your business, including rent, utilities, and office supplies.
- Operating Income or EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) – The gross profit of your business minus operating expenses
- Net Income – The income of your business after Interest, Depreciation, and Amortization
- Depreciation – The value of asset expenses over time.
- Income Tax Expense: The cost of estimated income tax your business paid or was owed for that period.
Cash Flow Statement
The Cash Flow Statement provides a detailed picture of cash activity during a specific accounting period for businesses that use the accrual method. It details the flow of cash into and out of your business. The cash flow statement is divided into three sections that show the cash flow:
Operating activities: Cash flow earned when your business provides goods or services. It details cash flow from net income or losses. It includes both revenue and expenses.
Investing activities: Cash flow detailing the purchase or sale of assets using cash only. These activities would include long-term assets like property and equipment.
Financing activities: this is cash flow from debt and equity financing. This includes selling stocks or bonds and acquiring or paying off a loan from a bank.
When looking at the cash flow statement, you can determine which activities generate cash. While you can partially analyze your company’s financial stability, your positive cash flow doesn’t mean that your company is profitable. You also need to analyze the balance sheet and income statement.
Using Financial Statements to Manage and Grow Your Business
There are several ways your business can use financial statements to manage and grow the business, including:
- Determine profitability and identify financial trends
- Learn the amount spent to manufacture your product or provide services
- Ascertain the amount of debt your company holds and its ability to pay it
- Understand the profit and losses for a specific period and identify increases or decreases compared to other periods
- Compare operational expenses against revenue generated
Summing it All Up
Not one financial statement will give you a complete picture of your company’s financial status. While we detail each financial statement independently, they are all interconnected. When used collectively, these reports provide valuable information you can use to make strategic decisions for your business. Much like a jigsaw puzzle, they tell an interesting story about your company’s past and future once put together.
Partner with Devine Consulting Today!
Understanding these financial statements, how they interact with one another, and how to retrieve the information you need will help you manage your company’s finances more efficiently. But we understand that your expertise lies in your industry. Our expertise lies in bookkeeping and accounting.
That’s why our clients partner with us! We help you manage your business’s financial recordkeeping and accounting. Get started today by requesting your detailed estimate or calling us at 281-545-4000.