Guide to Financial
Statements for 2022
For most people, and for most businesses, the new year means turning over a new leaf. So what does that mean for a small business's financial statements? How can a business owner go about preparing his or her financial documents for another year? There are plenty of important tips to keep in mind, but it's important to first understand the difference between the three most important types of financial statements.
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What are the Most Important Financial Statements?
There are three kinds of financial statement that are the most important for any small business. These are the balance sheet, the income statement and the cash flow statement. Your company's balance sheet, income statement, and cash flow statement work in harmony to provide a holistic view of your company's financial health. Each statement looks at your financial information from a slightly different point of view, and each is valuable in its own right. Let's break them down.
The balance sheet is essentially a snapshot of your company's total assets. Its bottom line tells you whether your company is above water, or in debt. It is a snapshot of whether the business is in a good financial position right now, and it can also tell you where the strengths and weaknesses of the company might be.
A balance sheet is created by breaking down your company's current financial position into three parts.
First, your assets. What does your company own? What positive assets do you possess? That might mean a vehicle, or other equipment, a patent or other intellectual property, existing inventory, liquid investments, or cash.
Next, calculate your existing liabilities. How much of your business loans are left to be paid off? How much do you owe in rent? How much do you owe on your company's vehicle?
Finally, the balance sheet will include your shareholder equity, which is essentially what would be left over if all your company's assets were liquidated and used to pay off the liabilities. Would your shareholders (you, other partners, investors) have anything positive to show?
In other words:
Assets = Liabilities + Shareholders' Equity
Your balance sheet essentially shows you your company's net worth at a given moment. This is an exceptionally powerful piece of data. It can be helpful as a tracker of your company's financial health, as one of many ways to gauge the value of your company, or as a way to help track your assets and liabilities.
If the balance sheet is a snapshot of your company's health, the income statement is like a photo album. Also known as a profit and loss statement, the income statement shows how profitable your company was over a particular period of time, typically monthly or annually. While the balance sheet shows total assets and liabilities, your income statement will show the total amount of revenue your company brought in during that period along with the total amount of outgoing cash.
Your income statement will take into account every single way your company lost or gained money in that period of time. It'll include your income, of course. But it'll also subtract all of your current liabilities: everything from taxes, operating expenses, rent, the cost of goods sold (known as COGS), interest on your business loans, and even depreciation on the value of existing assets. And at the end of all that calculation, you'll be able to determine if your company was profitable or not.
Cash Flow Statement
Even if your company shows a profit at the end of the year, you may still find that you're struggling to purchase inventory, invest in a new product, or cover payroll. That's because there's a big difference between profit and cash flow. Your cash flow statement will help track the latter.
Your balance sheet shows you at a glance if your company's got a positive net worth. Your income statement shows you how profitable you were over a given period. Your cash flow statement gets even more granular. It'll tell you exactly how, where, and when your company gained or spent its cash.
Every company is different. A fitness center, a software startup, a landscaping company, a hotel, and a bagel shop can all be profitable and rewarding. But the ways they'll spend their cash will be wildly different. The fitness center will likely see a predictable bump in revenue early in the year, as new gym-goers enter the facility hoping to turn over a new leaf, while the landscaping company is seeing its lowest days around that same time (unless you happen to run that landscaping company in one of the top warm-weather states in the country for small businesses).
The cash flow statement makes these high points and low points obvious. It'll help you plan for the most predictable boom and bust times, and ensure that your company has enough cash on hand to cover its operating expenses.
How can you make financial statements as useful and simple for your business as possible?
Your basic financial statements will help you plan for the future, analyze the past, and determine the best course of action for your business in the here and now. So it behooves every small business owner to make sure he or she is doing the things necessary to make their financial statements accurate and easy to produce. Here are some tips to help you do just that:
1. Pick a system (and stick with it)
Some small business owners may find that it's best to work with a financial professional to produce their financial statements every year. Others may take an accounting course to handle it on their own or rely on software to do so. Other may There's no right answer that encompasses every company. But no matter which way you choose to create your financial statements, you need to be steadfast in your choice.
That means that if you decide to run your financial statements through an online software in 2021, you need to make sure you're being fully transparent and using that software to analyze every possible bit of data. Financial statements aren't helpful if they aren't accurate or complete.
Here are some of the reasons why your small business should be utilizing financial reporting software.
2. Update your financial documents regularly
If you find yourself avoiding the work of updating all the relevant financial documents needed to even begin preparing your year-end financial statements, that's a sign that you need to be updating those documents far more regularly. There's practically no downside to keeping your company's finances even more up-to-date. You'll have a fuller and more current view of your financial performance and can use that information in the short term to fix small issues before they sink your entire year's finances.
If you get a new company credit card or business loan, you shouldn't hesitate to add those new liabilities to your existing bookkeeping. If your wholesale supplier updates a price for better or worse, get that updated quickly. And keep those updates consistent. Your business plan shouldn't show prices, projected revenues, and liabilities as you saw them a year ago. They should be kept up to date so that it can be easily used in cases of new financing activities, business valuation, or investor interest.
3. Understand the difference between financial professionals (and which ones you'll need):
Depending on the size, scope, and rate-of-growth for your business, you may or may not want to hire a professional dedicated to keeping your books, preparing your taxes, and other financial duties. But there are nearly as many different types of financial professionals as there are aspects of finance itself. Which position caters to which aspects of financial reporting?
A business's bookkeeper is essentially its boots on the ground when it comes to keeping track of finances. The bookkeeper will keep track of payroll, COGS, outgoing expenses like rent, equipment payments, and other operating activities. And that's all a bookkeeper will do: keep the books. It sounds simple, but the organization and classification of financial transactions can be a lot of work for a small business owner to take on him or herself.
Your accountant will take the data that's been organized and classified by your bookkeeper and conduct a thorough analysis of what you're doing well and where you can improve. If a bookkeeper and an accountant were looking at a closet, the bookkeeper would tell you which garment was a shirt and which garment was a sock; the accountant would be the one putting together outfits. Your accountant might notice that you've spent 15% more this year on one particular aspect of your company have actionable ideas for how you can cut back on that spending.
But an accountant does much more than that. They can also file taxes, assist with personal finances, and generally be more hands-on than a bookkeeper would be.
A CPA, or Certified Public Accountant, is essentially a highly-paid, licensed, and well-educated accountant. If bookkeepers classify clothes and accountants put together outfits, a CPA would be a professional stylist. They require state licensure, unlike accountants, and must be well-versed and up-to-date on the generally accepted accounting principles set forth by the Financial Accounting Standards Board (FASB). A CPA can be specialized in one particular area of accounting, like small business taxes, and must continue their accounting education through further accounting accreditations.
A CPA will certainly cost more money than an uncertified accountant, but they can also save massive amounts of money due to their deeper analysis.
A controller is essentially your business's financial tactician and manager of in-house accounting. If your company is growing rapidly, you may find that you've hired an accountant, a bookkeeper, and multiple employees in accounts receivable and accounts payable. If that were the case, your controller would be the mid-level manager in charge of all the above. They'd provide upper management with insight into financial successes and difficulties while also doing their best to manage the way money is spent on a granular level (while not necessarily enjoying high-level strategic input).
An executive-level position in charge of all financial strategy. Your CFO, or Chief Financial Officer, will make the case for all financial choices your company makes at the highest level. All accountants, CPAs, controllers, and bookkeepers would fall under the management of your CFO.
Which of these professionals does my company need?
It depends, naturally. In a small company that isn't generating a ton of net income, much of the accounting can probably be handled by a tech-savvy founder with access to online accounting and bookkeeping software. But a quickly-growing or middle-sized company's finances can be complex, time-consuming, and vitally important to continued success.
So evaluate your company. Are you spending a ton of time organizing your receipts and expenditures? Maybe it's time to hire a bookkeeper. Are you generally unfamiliar with accounting policies and don't know where to start with your financial condition? Look to an accountant. Remember that a CPA can be quite pricy, and that for many small businesses a CFO will rightfully ask for equity in the company as part of executive-level compensation.
Another thing to remember is that not all of the above are full time, year-round positions. You may want to hire a bookkeeper full-time to keep the tedious day-to-day finance work off your desk, but then go to a CPA for short-term analysis once or twice a year. There are many ways to use financial professionals to increase profits, reduce income tax load, ensure legal compliance, and generate your annual reports. And of course, many business owners handle accounting on their own.
4. Expect the unexpected
Your financial statements are a major part of determining the fair value of your company. So you'll want to make sure that, if it's at all possible, you're building room for unexpected expenses into your financial planning. You don't want to have to explain to a prospective lender why your statement of cash flows shows a period of two months when you weren't able to pay existing interest expenses because you hadn't planned on replacing a piece of equipment.
Giving yourself leeway for when life happens will ensure that your financial statements are assets to you and your company and can allow you to continue to grow, invite investment, and attract new business.
5. Automate things to keep it simple
Whether or not you choose to use financial professionals or software, do everything you can to take accounting and finance off your plate. For most accounting software, that can be done very literally. By linking your business credit cards or other forms of payment to your accounting software account, you'll be tracking those costs automatically. Accounting software can take much of the work out of accounting for busy company owners, doing everything from generating those vital financial statements to calculating payroll tax.
But if you're doing things manually or have hired a financial professional, do your best to automate your own behavior to make sure to keep life simple. That might mean building a block of time into your weekly schedule to send over the necessary paperwork for your bookkeeper to organize your finances, or it might mean establishing a weekly meeting with your in-house accountant in order to discuss strategy and tactics.
Build the habit of immediately setting your finances in order so that your end-of-year financial statements are a breeze.
6. Don't let accounts receivable grow stale
Nothing can be more frustrating to everyone in a business - from accounting to sales to executives - than growing lax when it comes to accounts receivable. Do your best to make sure that your clients and customers are paying your invoices in full and on time. That will prevent major cash flow issues while also keeping things more simple in the accounting equation. It can grow very tiresome and complicated to see that your company is waiting on a massive payment for a service already rendered.
Resolve to make 2021 a banner year for your company's financial statements.
By doing the right things on a day-to-day basis, you can build the foundation for an effective and profitable accounting department in your company. Prepare and evaluate your financial statements - your balance statement, income statement, and cash flow statement - in order to get a full view of where your company stands, why it stands there, and what you can do to grow in the year to come.
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