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As a small business owner, it is essential that you understand the financial health of your organization. If you run the business yourself, you may need to do some of the accounting for the business yourself. If so, there are three key financial documents you need to know: balance sheet, income statement, and cash flow statement.
3 essential financial documents for your business
These three documents provide essential information about your business. By creating and reviewing them periodically, you can gain insight into how your business is performing – and you can see the major issues that need to be addressed.
Here’s what you need to know about each document.
1. Balance sheet
Your business’ balance sheet is a statement of your assets, liabilities and equity at a specific point in time. It gives you an overview of where your business is in terms of what it owns and how much debt it has outstanding.
Typically, companies organize a balance sheet by listing their assets on the left and their debt and equity on the right.
Ideally, your business should be balanced, which means that the total value of assets is equal to or greater than the combined value of your debt and equity. When you look at your balance sheet, you can see how much your business is using its assets to generate income rather than debt.
The reports must be completed and reviewed regularly. Some companies update them monthly, while others update them quarterly. By sticking to a schedule, you can track the progress of your business.
2. Income statement
Your business’ income statement, also known as the income statement, details the income of your business. It helps you determine if your business is currently making money or not, and how much.
The income statement is for a specific period of time. Depending on your business needs, you can itemize your business’s profit and loss for a month, quarter, or year.
It will list:
- Income: Your income is any money deposited into your business checking account from the sale of products or services.
- Expenses: Your expenses are your financial costs, such as rent, utilities, labor, marketing, taxes, and debt payments.
- Net profit : To calculate your bottom line, you subtract your expenses from your income. If your income exceeds your expenses, the resulting number is your bottom line. If not, the number is your total loss.
You can use the income statement to determine the health of your business and see how important your profit margins are at any given time.
3. Cash flow statement
the Cash Flow gives you information on how the money goes into the business and how it is spent. There are three key sections:
- Operations: This section presents the cash flows at the heart of the company’s operations, such as its production costs and total sales. Your operational cash flow can give you an idea of your ability to grow your business, launch new products, or reduce your debt.
- Invest: The investment part lists the company’s investments in assets, such as real estate or equipment, as well as any investments it makes in securities. A positive cash flow can be a good thing, but it can also be a sign that you are not investing enough in your future. Negative cash flow can indicate that you are investing in long-term growth.
- Funding: The financing section is a list of the company’s debt, such as business loans. Your financing cash tell you how well you are managing your debt.
How these three documents intersect
While all of these documents are important, you should not read them alone. Instead, they should be used together. The documents overlap strongly and affect everyone’s data. Your net income from your income statement is transferred to your balance sheet as retained earnings, and the closing balance on your cash flow statement populates the assets on your balance sheet.
By looking at the three documents, you can analyze the performance of the company from different angles. For example, the balance sheet and cash flow statement tell you how much capital your business has in relation to its debt, while the income statement tells you what your profit margins are.
How lenders use your financial documents
If you are applying for credit for your business, such as a small business loan, lenders will ask you for these three documents because, when used together, they give a complete picture of the financial health of your business.
Lenders will first look at the balance sheet so that they get a full picture of your assets and liabilities. They will often ask for balance sheets for the past three years and forecast balance sheets for the next two years.
They will look at your tax returns for the past three years to see your business’s profits and earning potential in the future. Finally, they’ll review your cash flow statement to make sure you have enough money to cover your expenses and loan repayments if a loan is approved.
Creation of your financial documents
If creating these three key financial documents seems overwhelming, keep in mind that you don’t have to do it alone. While you can create them yourself, it might not be the most efficient use of your time.
As your business grows, it is essential that you maintain good accounting practices. It may be a good idea to hire an accounting professional to help you with your bookkeeping and create these financial documents for you.
here is what to consider before hiring an accountant for your small business.
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