In a business of any size, financial reporting is critical to the success of the organization. Why are financial statements important? Because when stakeholders need a clear financial picture of your organization, financial statements are the first thing they turn to. The process of financial statement preparation is an important one to be familiar with, whether you require these statements annually around tax time, or on a more regular basis.
Primary Documents in Financial Statement Preparation
Although every business has its own unique aspects, they all have one thing in common – the need for 3 primary documents in the financial statement preparation process. Generally, the 3 financial statements in accounting are the balance sheet, income statement, and cash flow statement. Businesses update them on a monthly, quarterly, or annual basis, depending on the business.
Understanding these three financial statements is key to making informed decisions about the financial health of your business. These are the three documents and a brief summary of what they are used for in a business.
The Balance Sheet
A balance sheet is a snapshot of a company’s financial position at a specific point in time. It includes company assets, liabilities, and equity. Its purpose is to illustrate your business’s financial position and whether you have more assets than liabilities (i.e. positive net worth).
The Income Statement
The income statement is a summary of a company’s revenue, expenses, and profit (or loss) over a specified period of time. An income statement helps you understand your business’s performance and net income, and whether it is generating a profit.
The Cash Flow Statement
A cash flow statement shows changes in a company’s equity over a specified period of time, including contributions from shareholders, profits and losses, and distributions to shareholders. It shows you how much cash you are generating from operations, investing activities, and financing activities, and helps you understand whether you have enough cash to meet your financial obligations.
Does your business have these reports? And if so, what do you use them for? There are several main reasons that businesses need these 3 financial reports.
Why Your Business Needs the 3 Financial Statements
Financial statements are an important tool for small businesses, as they provide valuable information about the company’s financial health and performance. Businesses use them in a number of ways, including:
- Make decisions: The information in these reports provides the data and insights needed to make informed decisions about the future of the business, such as whether to invest in new equipment, expand operations, or seek additional financing.
- Monitor performance: These reports help small business owners track their progress and identify areas that may need improvement. With this information, business stakeholders can track changes in revenue, operating expenses, and profitability over time.
- Plan and budget: These 3 types of financial reports provide the basis for creating a budget and financial projections, allowing you to plan for the future and make informed decisions about your resources.
- Tax planning and compliance: Financial statements provide the information needed to accurately report business income, expenses, and other financial transactions to the tax authorities.
- Apply for a loan: Financial statements are often required for loan applications. They provide lenders with a snapshot of a small business’s financial position and ability to repay the loan. Since loans can be so important in a business, we will delve a little deeper into that reason for these documents.
Financial Statements for a Bank Loan
Loans can be a key source of cash flow you need to fund a small business. The exact financial statements required when you apply for a loan will vary depending on the size and type of loan being sought, as well as the financial history and condition of the business. However, common financial statements required for a bank loan include the 3 types of financial statements (balance sheet, income statement, cash flow statement) plus a business plan.
Here is how banks use each statement, plus their need for another important document, your business plan:
- Balance Sheet. Banks use the balance sheet to assess your business’s ability to repay the loan.
- Income Statement. An income statement is used by banks to evaluate your company’s financial performance and stability.
- Cash Flow Statment. A bank uses the cash flow statement to assess your company’s ability to generate positive cash flow and to service its debt obligations.
- Business Plan. In addition to the 3 financial statements, a business plan is often required so the bank can assess the viability and potential of your business. A business plan outlines your company’s strategy, marketing, and sales plans, financial projections, and other key information in detail.
Beyond these documents, banks may also require other information such as personal financial statements for your business’s owners or guarantors of the loan, tax returns, and relevant financial information. The bank will use all of this information to determine creditworthiness and make a decision on whether to approve the loan.
The Importance of Accuracy in Financial Statements
Having the necessary types of financial statements for your business is one thing – having accurate statements is another. When Simply Counted reviews financial statements for businesses that first retain our services, 90% of the financial statements are found to be inaccurate.
The reasons for inaccuracy vary greatly depending on several factors, including:
- size and complexity of the business
- quality of its accounting and record-keeping systems
- level of expertise of accounting staff
- internal controls in place
Even with the best systems and personnel, errors and discrepancies can still occur in financial statements. That’s why it is important to regularly review your financial statements and have them audited by a qualified professional, in order to ensure their accuracy and integrity.
Financial Statement Compilation and Review
Financial statements are an essential tool for small business owners, providing valuable information about the health of the company. Once you’ve compiled the 3 types of financial statements, there are many ways to use them to your advantage. The financial statement review is a step where positive and negative trends, abnormal expenses or gains, and much more can be discovered. Compiling the statements alone is of no use unless they are reviewed and interpreted so your business can make better decisions moving forward.
Simply Counted’s Accredited Business Accountants (ABA) offer financial statement services to compile your business’s financial data and arrange it into conventional financial statement form on a monthly, quarterly, or annual basis. We also offer a financial statement review service where an ABA will apply analytical procedures to identify unusual trends that may need explanation. Finding inconsistencies in your business’s financial health as soon as possible can make all the difference in successfully growing your business. Contact us for assistance in this very important area.
About the Author
Diana Kasza
President of Simply Counted Business Services, Inc.Diana is an Accredited Business Accountant/Consultant with more than 25 years of experience. She is a graduate of Ferris State University and an active member of Toastmasters International.