It’s critical to understand financial statements: the fundamental building blocks that help assess a company’s health. They are the lifeblood of every business, highlighting key areas of your organization’s financial performance and overall financial position. To be successful, every business owner or investor must understand their financial statements to make informed decisions, as they reveal many aspects of a company’s operations, cash flow, and profitability.
So we asked Jessica Zoraida, CEO of Big Picture Results, to provide an introduction to financial statements and help a beginner understand the basics of financial statements – the balance sheet, income statement, and cash statement, along with their elements, importance, and interrelationship that provide one view of the financial position of a company.
Whether you’re an investor, business owner, or just looking to expand your financial literacy, understanding financial statements is crucial for making informed decisions. Join Jessica as she walks you through the different types of financial statements, how they work, and why they matter for your financial analysis.
KEY TERMS
Financial Statements
- Profit & Loss or Income Statement – determines whether you are profitable (Net Profit) or not (Net Loss) as a result of Operations (Income – COGS – Expenses = Net Profit or Net Loss)
- Income – Monies generated as a result of Business Operations. Consider:
- Differentiate between Service and Product based
- Sales Tax – collecting and remitting
- Discounts
- How you will handle Refunds
- Digging Deeper – how you are pricing your Services or Products?
- Cost of Goods Sold (COGS) – Variable cost of doing business. This is what it takes, or cost of your inputs in generating Income. The goal is to realize Economies of Scale where you are generating proportionately more Income over time vs. COGS. Hence, COGS growth over time should trend disproportionately lower vs Income, favorably increasing Gross Margins.
- COGS – Supplies & Materials
- COGS – Labor (Sub-Contractors), review Form-1099 rules
- COGS – Merchant Fees – different than Bank Charges, Fees, or Loan related items. This is the transactional processing cost associated with Income receipts and trend to or around 2.9% and higher. Some States such as CA, allow you to recoup these costs in the form of ‘Surcharges’ billed to your Customers, review rules before changing how you Invoice, etc.
- Expenses – this list is not exhaustive. The rule of thumb is stick to IRS best practices for building out your Accounting infrastructure. Use the categories found on either a Corporate Income Tax Return Form 1120 or Schedule C of a Personal Income Tax Return Form 1040.
- Advertising – recommended no more than 1% of Income, and must be able to determine ROI by tracking leads, etc.
- Auto – expectation is Auto is used for business purposes. There are several sub-categories of Auto that should be built out within your Chart of Accounts.
- Bank Charges and Fees – different than Interest Expense or paydown on Loan principal. These are the admin fees associated with maintaining bank accounts, incidental bank fees, CC annual fees, etc.
- General & Admin – this includes Computer & Internet, Dues & Subscriptions, Office Supplies and General.
- Insurances – policies include General Liability, Professional Liability (Errors and Omissions or E&O), Business Owner policy includes both General and Professional Liability, Workers Compensation, Key Man Insurance.
- Interest Paid – on Debt outstanding, ‘Vendor’ should correspond to a Loan Liability account on the Balance Sheet.
- Payroll Expenses – includes Salaries and Wages, Bonus, Employer Taxes, Reimbursements, Service Fees, Healthcare and Retirement Plan contributions. Payroll and related taxes must be reported and filed Quarterly (941) and Annually (940) as well as reconciled vs W3, summation of all filed W2s for Employees.
- Professional Expenses – Accounting, Legal, Outside Consultants o Rent & Lease – for business use and agreements in business name.
- Taxes & Licenses – Income taxes paid, required State and Federal licenses
- Telephone Expense
- Travel – Business Travel
- Balance Sheet – presents the overall health of your organization as it pertains to the mix of Assets, Liabilities, and Equity.
- Assets – Financial accounts, Property, Equipment, and Intellectual Property that your company owns and that vary in value and liquidity (ability to convert to cash) with cash being the most liquid.
- A/R – Accounts Receivable, a current Asset that represents the amount of money your Customers owe you for Goods or Services rendered. Reporting is usually reviewed over a horizon in 30-day increments.
- Liabilities – what your company owes in outstanding debt. This includes balances on Credit Cards, Notes Payable, Short and Long Term Loans, Lines of Credit.
- A/P – Accounts Payable, a current Liability that represents the amount of money you owe your Vendors (you’re their Customer) for Goods or Services they have rendered to you. Reporting is usually reviewed over a horizon in 30-day increments.
- Equity – ownership retained in your company either through internal founding (‘sweat equity’) or by raising capital from outside investors.
- Various terms representing Equity ownership (Member, Shareholder, Owner) depends on the Legal Entity of your business (LLC, Corporation, Sole Prop, respectively.)
- Contributions – monies drawn out of company accounts
- Distributions – monies deposited into company accounts
- Assets – Financial accounts, Property, Equipment, and Intellectual Property that your company owns and that vary in value and liquidity (ability to convert to cash) with cash being the most liquid.
- Accounting Equation
- Assets = Liabilities + Equity
- The things of value that your firm owns were paid for EITHER via Borrowing (Liabilities) or Capital Raising/Giving up ownership (Equity).
KEY TAKEAWAYS
WHY is it important to understand Financial Statements?
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- There is a lot of fear and discomfort around working with financial statements, accounting, and tax
- It is important to get a handle on these areas of your business so that you have a clear understanding of your company’s financial standing which directly correlates to your ability to grow, borrow, take on outside investment, etc.
- The benefits are better access to capital at preferred rates, being able to proactively plan business spending, operations and investment activities, and also be able to present to future stakeholders (lenders) or investors that may have capital to help you grow your business
- The risks of being in the dark is losing money, being ineffective, unable to control costs because you don’t understand them, and not accessing information timely for decision making. Behavior is reactive instead of proactive.
- Get there by understanding the basics, sticking to best practices and working with those that have expertise so that things are done right.
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For more information on how to most effectively put these strategies to work for your business, contact Jessica Zoraida, CEO of Big Picture Results, at jessica@bigpicresults.com.