Important Financial Documents
Financial documents set the benchmark for businesses regardless of their size. To measure organizational health, startups and small businesses rely on financial reporting. When an entrepreneur wants to set up the business, he needs to focus on the time and day-to-day operations that need evaluation and record-keeping at the same time. So financial documents represent two sides of the coin; profit and loss. Both factors are independent. The size of the firm doesn’t matter.
But how does a small business keep up with their profits and losses?
Why do financial documents set a benchmark for businesses?
A financial document may be the most complex record, but putting the profits and loss statements into writing is how an entrepreneur can evaluate the success or failure of a business. For a business to have sturdy growth, it is vital to keep a close eye on the cash flows.
Perhaps, when a small business fails to keep tabs on the debit and credit side of the ledger, no proper recording of income statements, and so on, you cannot make a proper decision based on lacking revenue and capital or equity. Business is destined to fail.
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So even small business startups keep your focus on the following financial documents that will help regulate the business income and to make the debit side better than your credit side.
Balance sheet – a mirror on the wall
A mirror on the wall never tells a lie about the reflection. Imagine a balance sheet equivalent to that mirror. All your debts, credits, and equity, etc., everything is laid bare on it. To gauge the financial worth of a business head for the balance sheet.
The balance sheet is the summarized version of the business that indicates whether the business is earning profits or pitching towards loss. A balance sheet is comprised of three major columns;
- Owner’s equity
Assets are usually divided into two categories in terms of qualitative factor;
- Tangible (you can see, touch, and feel them like furniture, land, or building)
- Non-tangible (invisible but have an eminent presence like goodwill, copyrights, or patents)
Long-term assets (usable for more than 5 years) and short-term assets (usable for less than 5 years) are also kept included in the balance sheet. Any item that comes under the working tenure of a business that provides some benefit to run the business is an asset.
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- Liabilities are the obligations that a firm owes. It represents the credit side of the balance sheet. It shows the amount that a business owes to the customers, banks, or suppliers, etc. Liabilities can be a borrowed amount, loan, or even shown as payables (account payable).
- The owner’s equity represents the remaining balance after assets are used to pay the expenses and to minimize the liabilities. The remaining assets and capital is known as the Owner’s equity. It depends on the owner what he decides to do with the remaining shares.
At the end of the year, an income statement shows your progress – consider it like a progress report of your business.
The income statement is directly perpendicular to the balance sheet, meaning that it shows the profits and loss at the end of the annual statements with equal time intervals. It shows whether a business earned profit or faces loss. The debit and credit side of the statements are the two focal points. For a business to earn a profit, debit statements must surpass the credit statements, then the end year profit is calculated by subtracting the debit and credit.
Usually, income statements can be single-lined especially for small-scale businesses. However, the known 4 elements of an income statement help deduce the profit/loss.
- Revenues are the gross receipts that a company earns when they sell a product/service.
- Expenses are the costs incurred to earn the revenue.
- Gains are the part of income that is earned from non-business-related transactions, like selling or buying an asset.
- Losses belong to the credit side of the income statement that shows how much money the company lost in a sale.
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The bottom line is when an investor takes a look at your income statement, he will assess the productivity (selling or buying/revenue or expenditures) from the records. They will evaluate how much leftover cash is or whether it will be worth investing in a small business or not.
Cash flow statement
If your income statement is showing profits, it doesn’t necessarily mean that you are generating profits. Cash outflows may be surplus than cash inflows.
How is the cash flow statement any different from an income statement?
It is quite similar to the income statement. It is concerned with the company’s profitability. But the primary function of this statement is to look at the cash inflows (how much money is coming into the business) and cash outflows (how much money is going out).
A cash flow statement helps a business to operate more efficiently if you have the records that distribute the fixed and variable costs that are to be paid by the business. So a cash flow statement helps to know whether a business can generate the required amount or not.
So, to operate a day-to-day operation, or to make long-term investments cash flow statements help to plan these activities too.
Usually drawn at the end of the accounting cycle, cash flow determines how you can expand your business. Even if you plan to localize in a new market, then it is possible to do so by having a detailed eye on the financial statement.
At the end of the year..
The above mentioned are the basic statements that show a business its viability to move ahead or to put an end to it. By calculating the revenues and expenditures at the end of each accounting cycle, a small business can acknowledge its market position. Managing a business is not an easy feat, especially if a small business is looking for expansion.
As a small business owner, if you don’t want to fizzle out from the competition, then make your business decisions based on these financial statements. The real challenge is to sustain your business.