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Guide to financial statements

From small business owners to seasoned executives, understanding a company financial statement is a vital part of accounting. It’s also important for investors to learn about financial statement analysis in order to take stock of a company’s performance. Here’s what you need to know about creating, reading, and analysing financial statements.

What are financial statements?

A standard financial statement can refer to a few different company accounts. Depending on the type of statement, it gives you useful information about profits and losses, cash flow, and expenses. One typical financial statement example would be the company balance sheet.

Statements are usually drawn up either monthly or quarterly, though some high-volume businesses might need to keep them updated from week to week while others will compile annual reports.

Financial statements can be generated by your bookkeeper or accountant. Many businesses choose to use accounting software, which automatically generates the most important financial statements.

Types of financial statements

Some businesses require more detailed records than others for accounting and tax filing purposes. Generally, HMRC and Companies House suggest that UK businesses keep the following company financial statements as a minimum. 

1. Cash flow statement

How does a business spend its money? During the normal course of business operations, cash flows in and out of company accounts. While a standard financial statement measuring profit and loss only records revenue as sales are made, the cash flow statement can be used with the accrual method of accounting.

When reading this financial statement, you’ll see that it’s broken down into three categories.

  1. Operating activities describe how much cash is coming in from daily operations, like the sales of goods and services. It also shows how much cash is flowing out of the business accounts due to everyday operations.

  2. Investing activities show how much cash the business is spending on new equipment or other items needed for growth.

  3. Financing activities show incoming and outgoing cash flow related to investment activities, like selling stock or taking out a loan.

All of these inflows and outflows are added together to determine whether cash flow is positive or negative. This is useful for investors, who can see how a business is performing as well as how well it’s handling its day-to-day expenditure.

2. Profit and loss statement

The second financial statement example we’ll cover here is the profit and loss statement. As its name suggests, this statement shows you how much money your business has earned, and how you’ve spent it during the accounting period in question. There are two main sections to the profit and loss statement:

  • Total Revenue: Total revenue, or billed income, shows you both invoiced sales as well as the cost of goods sold (COGS), which is subtracted from sales to arrive at your total profit.

  • Total Expenses: This section shows any additional expenses not covered in the COGS.

The profit and loss statement also tracks important factors like depreciation and amortisation, which show how assets have declined in value over time.

By tracking income and expenses, you’re able to see which types of expenses have the greatest impact on your business revenue. You’ll also need this information for filing taxes with HMRC. From an investment perspective, a financial statement analysis based on profit and loss can help uncover how sustainable a business model is.

3. Balance sheet

Last but not least, the balance sheet is one of the most important working documents in accounting, giving an easy snapshot of your business’s standing at a glance. You should be able to track and manage debts, manage financial standing, and file taxes using information generated during previous accounting periods. The balance sheet consists of three components:

  • Assets: Money that the business has to work with

  • Liabilities: Money that the business owes

  • Equity: The money invested in the business

Together, these three components should always be in balance according to the accounting equation:

Assets = Equity – Liability

Assets include both fixed assets, like property and vehicles, as well as current assets, like cash and inventory. Liabilities can also be short and long-term in nature. With the balance sheet, you can perform a financial statement analysis like calculating the business’s liquidity ratio:

Liquidity Ratio = Current Assets / Current Liabilities

If the liquidity ratio is less than 1, this means the business might have difficulties paying off its current liabilities.

The bottom line

As you can see, a company financial statement reveals quite a lot of insight into how well a business is managing its money. By looking at examples like the big three above, you can take quick stock of a company’s financial health, learning more about profits earned and growth potential. For business owners, these statements also provide a vital resource when it comes to generating new investment interest.

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