Understanding accounting, the language of finance and business, is crucial knowledge for all business owners and entrepreneurs. When starting a business, learning how to read financial statements is as important as managing other business tasks. It is more critical to understand statements rather than to continue investing money blindly.
Over time the business will expand, and transactions with other businesses, tax authorities, and people will have to be made. Business bookkeeping needs to be counted and rechecked. These transactions of business and records are maintained using various financial statements and accounting terms.
First of all, the following three are the most important financial statements in business bookkeeping.
1. Income Statement
The Income statement is divided into Sales and Expenses and includes the following:
Sales include: The selling of goods and services to the customers and getting monetary payments in return.
Expenses include: The purchases made on behalf of the business, employee salaries, bank loans that were received for investment or other purposes, and tax expenses that were paid as income taxes, etc.
2. Balance Sheet
A balance sheet is a collective form of the statement made based on all past transactions. It categorizes assets and liabilities.
Assets can be fixed assets as well as cash in the bank. It also includes the raw materials, work in progress that will yield profit, finished goods, and value-added tax. Value-added tax is the amount of money that a IRS owes you.
Liabilities comprise the payments that have to be paid by the company/business. It includes the gross amount of money that has to be paid to suppliers. Value-added tax liability is money paid to tax authorities for the sales that were done. Debt is the amount of money that has to be paid by the company to banks or other sources.
A balance sheet needs a balance.
3. Cash Flow Statement
A cash flow statement shows the cash (money) that flows in and the money that flows out.
A cash flow sheet includes the investing and the financing cash flow. Investing cash flow is the invested cash in the fixed assets in the business. The Financing cash flow describes the money in cash from the investors received from the investors or paid to the investors.
A third but significant form of cash flow is “Operating cash flow.” It explains the money flowed-in and flowed-out to the running business.
These three cash flows are added, and it shows the change in the amount of cash.
The above three financial statements are interrelated. As the incomes and expenses statement increases, the assets and liabilities on the balance sheet will increase. The assets and liabilities will decrease as per the cash flows from the cash flow statement.
Knowledge regarding financial statements interpretation is essential for entrepreneurs. Entrepreneurs need to know critical information in the credit analysis of their business. Investors and entrepreneurs must understand how accounting is done in businesses. Accounting is the language of business. But, learning the meaning of a few terms used in accounting is not enough. Entrepreneurs must understand the parts of the above described financial statements. This will help the entrepreneurs determine the values of assets. They will be able to calculate profitability and also estimate the risks of the assets of the company. They can understand the company’s financing sources. Entrepreneurs must understand the investment, credit analysis, and profitability.
Business owners/entrepreneurs can determine debt and equity with accounting knowledge in business financing. The ability of entrepreneurs to identify debt and equity shows insight into the value of a company. Understanding and accounting statement is vital for running a successful business.