Staying on top of your business's financial health is key to your long-term success. If you don't stick to your budget or keep an eye on your cash flow, you risk overspending and going into debt. By using the various financial statements strategically, you stay informed about your finances and are ready to address budgetary struggles.
What Are Financial Statements?
Financial statements are any official reports that provide information about your company's finances. One of the most common is an auditor's report, generated after auditing services inspect your books and tax records. In this report, auditors write whether your company's practices align with generally accepted accounting principles. If your financial records appear to be in order, you receive an unqualified opinion report, meaning that the auditors think you adhere to GAAP. If you receive a qualified or adverse opinion report, the auditors have found a discrepancy between your financial records and their actual state. An adverse opinion report is more serious than a qualified one, but both can result in legal penalties or fees.
Another type of financial statement is an income statement. This statement is less official than an auditor's report because you generate it yourself, but it is still essential for determining your business's financial health. When you create your income or profit and loss statement, you record your total revenue and your total losses for the year. When you file your taxes, you must submit an income statement because it determines how much income tax you pay. If you have international income, consider working with an international tax advisory, since the situation is much more complicated.
Cash flow statements are similar to income statements but are not part of your annual taxes. In this report, you provide details about how much you spend on materials and how much you earn from every client. For example, if you run a reusable water bottle company and purchase your plastic from the same vendor six times a year, each of those transactions goes on your cash flow statement. That way, your investors can see exactly how you're spending your money and can determine if you're heading for financial difficulties.
Balance sheets also keep track of how much cash is entering and exiting your business. However, these forms are intended to calculate your net worth at any given time. To create a balance sheet, you make a chart listing your assets, liabilities, and equities. Your assets include your profits from sales as well as any machinery or property that you can use as collateral. Your liabilities include the cost of materials as well as your rent and utility bills. Finally, your equities are the shares that investors have in your company. If your assets are worth less than your liabilities and equities, you have a negative net worth. Companies in this situation must act quickly to prevent bankruptcy.
How Are Financial Statements Used?
The various types of financial statements are all crucial for your long-term success. If you fill out your statements accurately, it's easy to complete your taxes every year. Even forms that aren't required by the government, such as balance sheets, ease your way through Forms 1040 and 1060. By having all your financial information neatly organized, you have an easier time spotting potential tax breaks, such as deductions for charitable donations. Finally, if you do get audited, you have all your documents ready for the process.
Financial statements are also useful when you're meeting with investors. Your investors don't want to lose money on your business, so you must assure them that you're putting their capital to good use. When you come prepared with detailed cash flow statements and balance sheets, you prove that you're spending your money wisely. You also demonstrate that you're capable of careful budgetary preparation and execution. These skills make your supporters more willing to trust you with bigger investments.
Another use of financial statements is determining whether your business is ready for an expansion. You've often heard that businesses must continually grow or else risk becoming obsolete. While stagnation is a real concern, you also need to avoid overextending your finances. If your cash flow statements indicate negative cash intake and your balance sheets reflect negative net worth, now is not the time to take out loans or make major purchases. Sometimes, your numbers are not so dramatic that it's immediately obvious whether your business is financially healthy. When you're in this situation, consult with an accountant and your investors to determine your course of action.
Creating financial statements for your business allows you to assess your company's health, prepare for tax season, and provide your investors with the most accurate information. As you generate these forms, ensure that you use up-to-date data, or else you risk creating statements that don't reflect your business's finances.