Financial statements are reports that summarize the financial condition of an organization on a specific date. Three principal types of financial statements are: the Income Statement, which tracks the organization’s income over time; the Balance Sheet, which is used to view the organization’s net worth at a particular time; and the Cash Flow Statement, which reports how much cash the organization has on hand.
Income statement. The Income Statement figures net income, or the bottom line. Net income is calculated by adding all business revenue, and then subtracting all costs and expenses of operating the business. Net income is also referred to as net profit. An Income Statement is an extremely useful tool for a small corporation, and can be used for projections, tax purposes, to evaluate your corporation, and to attract investors. An excellent way to understand your corporation’s financial condition is to compare the numbers on your Income Statement with the budget for the same time period.
Although an Income Statement can be simple and include only revenues, expenses, and net income, more detail can be very helpful, and ultimately serve as a chart of accounts for the corporation.
Key components in an Income Statement include:
Gross sales (or gross revenues); Returns and allowances; Costs of goods sold; Sales-related, general, and administrative expenses; Income taxes; Net income (or net profit).
Balance sheet. The Balance Sheet shows the corporation’s financial condition as of a specific date. It shows what the business owns (assets) and what it owes (liabilities). The difference between the two represents the corporation’s equity (net worth). More than one period of time can be shown on a Balance Sheet to demonstrate increase (or decrease) in net worth.
There are three major types of assets:
Current assets. Those assets which you expect to convert into cash within one year. They include: cash, investments, accounts receivable, and inventories. Fixed assets. Property, plant, and equipment items that are expected to last longer than one year. A dollar amount is usually given for items in this category. Other assets. These are long-term assets, and include a lease deposit, and intangible items such as good will.
Liabilities are the corporation’s debts, and fall into two categories:
Current liabilities. Business debts that are due within one year. The portion of long-term debt due within one year should also be included under current liabilities. Long-term liabilities. Business debts that are due one year and beyond the date of the Balance Sheet.
Net worth. Net worth, or owner’s equity, is the corporation’s net worth, and consists of capital that was invested in the corporation, along with accumulated earnings that have been left in the corporation. Invested capital exists in the form of cash or other assets transferred to the corporation. Retained earnings are the corporation’s accumulation of profits and losses over time, which are reduced when the owners take money or profits from the corporation in the form of dividends or a draw.
Cash flow statement. The cash flow statement tracks the corporation’s cash position over time. A traditional cash flow statement is broken down into three major categories: operating activities, investment activities, and financing activities. The statement is used to show the cash position during the current period and the desired period, and sets forth the increase or decrease in cash and percentage change between the two periods.
Forms representing the various types of financial statements are available for review at AllBusiness.com’s Incorporation Forms.
For more information, read Making Sense of Financial Statements. AllBusiness.com’s comprehensive review of Business Cash Flow Management Tools is also a useful guide to this topic, which is critical to business survival in both good times and bad.