The goal of every organization, especially a profit-making organization, is to maximize profits and minimize losses. If this must be achieved, then accurate transactional records of the business must be kept and reviewed periodically. Thus, this would require that a functional accounting system be set up to keep track of all financial transactions related to the business.
Setting up this accounting system would involve using some financial tools, which include a financial statement. Here we would be looking at a financial statement and balance sheet related to the growth of your business.
What is a Financial Statement?
A financial statement is a document that tells you the financial state of your company by the end of the accounting period. It gives you an overview of all your financial transactions and activities within a time frame, relating the extent of efficiency and profitability of your company.
A company’s financial statement expresses the financial health condition of the company, as it provides several transactional information on weekly, monthly, quarterly, and yearly intervals, which can be used for proper financial analysis and decision making. A financial statement consists of four major documents: cash flow statement, profit and loss account, statement retained earnings, and the balance sheet.
Here we would discuss the balance sheet as a financial statement component and how it relates to your business. But before then, let’s briefly discuss the three other components of a financial statement.
What Is a Profit and Loss Account?
A profit and loss account is also known as an income statement. It helps determine the profitability of your company as it shows you the profits and the losses of your company for a particular period. It shows the company’s net earnings, be it positive or negative, summarizing the revenues and expenditures of the company. You will see a figure tagged net profit or loss at the end of a profit and loss account.
Here is how to get the final figure for your income statement
Net profit = Gross profit – expenses
Gross profit = Income (Revenue)- Cost of goods sold (CoGS).
What is a Cash Flow Statement?
A cash flow statement shows the total amount of cash flowing in and out of the company weekly, monthly, quarterly, or yearly. The cash flow statement has three categories, the operational part, investment, and that financing.
Operational
The operational category consist of net income, adjustments for depreciation, adjustment for increase in inventories, and adjustments decrease in accounts receivable, which all equates to the net cash flow for operations.
Investment
The investment category consists of cash receipts from the sale of property & equipment. Cash paid for the purchase of equipment which will equate to net cash flow from investing.
Financing
The financing category includes the cash paid for loan repayment which equates to the net cash flow from financing
What Is A Statement of Retained Earnings?
This financial statement tells you the changes in equity that occurred in your business within a specified period, usually a year. A retained earnings statement consists of changes stemming from your business profits and losses, payment of dividends, and the sales of stock or repurchase.
Balance Sheet
A balance sheet is a statement that shows your business assets, liabilities, and equity. It reveals the truest financial state of your company since it tells you what your business owns in the place of its assets, what it owes others in the place of its liabilities, and what you and your stakeholders contributed to the business in the place of its equity.
Items on a Balance Sheet
A standard company’s balance sheet has two main sides: the asset and equity & liability sides. Both have their current and noncurrent aspects, each item appearing in its order of liquidity.
By order of liquidity, it implies the speed at which the assets can be converted to cash. However, shareholder’s equity could be considered a third.
#1. Assets
Assets are considered all revenues or income accumulated by a business over time and can be used for further increase in the business’s profitability. The items contained in assets are current assets and non-current or long-term assets.
Current Assets
Current assets can easily be liquidated into cash within a short period. The current account is further sectionalized into units which are; Prepaid expenses, Account receivable, Inventories, Cash and cash equivalents,
Non-current assets / long term assets
Long-term assets include equipment and property, Goodwill, market securities, and intangible assets such as patent rights.
#2. Liabilities
The liabilities of a company are the debt held by the company in addition to its recurring expense. The items on the liability side include current liabilities consisting of payrolls and interest rates, rents, taxes, utilities, and unearned revenues. Long-term liability consists of pension funds, long-term loans, and deferred income tax.
#3. Shareholder’s Equity
The shareholder’s equity is the contributions or investment made by the shareholders for the running of the business. It consists of equity capital and retained earnings.
How to Balance Your Balance Sheet
A financial statement, particularly the balance sheet, ought to be balanced after every accounting period. It is said to be balanced if your total assets equal the summation of your liabilities and your shareholder equity. The arithmetical expression is stated as
Asset = Total Liabilities + Shareholder equity.
Importance of a Balance Sheet
The balance sheet is a significant financial summary that gives a preview of the financial state of your business at a particular. A balance sheet is significant to your business on the following grounds:
Proper Decision Making
It serves as a decision-making tool for stakeholders and potential investors. Since it gives an overview of the financial health of the business
Liquidity Level
It shows the liquidity rate of the business. It tells how much flows in and out of business and gives you the current state of the business at any point in time, showing you how much the business has in hand or at the bank per time.
Loan Requirement
It is usually requested by banks, loan, or investment companies if they intend to do any form of financial transaction with your business.
Efficiency Rate
It can be used to measure the efficiency of a business, especially when analyzed with other forms of the financial statement, that is, the cash flow statement, the income statement, and the retained earnings statement.
Disposable Leverage
The balance sheet informs you of the extent of leverage a business has at its disposal. This can be determined by comparing your business’s equity base to that of its debt.
Risk Management
It also aids in risk management. With the details available in your business balance sheet, you can tell if the business is fit to go for high or moderate risk expansion if it intends to do so.
Conclusion
A balance sheet is an important tool needed for the growth of every business, be it large scale or small scale, public or private owned. It is essential for decision-making, as explained above, so proper recording of all financial transactions or activities carried out by your business should be done to get the best results from using a balance sheet.
