It's not the flashiest part of running a small business, but analyzing the financial data from your small business on a regular basis is vital to the health of your company. Maintaining the proper financial statements helps you determine your business’ financial position at a specific point in time and over a specified period.
Information from your accounting journal and your general ledger is used in the preparation of your business’s financial statement. The income statement, the statement ofretained earnings, the balance sheet, and thestatement of cash flows all make up your financial statements. Also, information from the previous statement is used to develop the next one.
Key Takeaways
- Financial statements must be prepared at the end of the company's tax year, but some companies update them as frequently as each month.
- A financial statement is made up of four main documents: the income statement, statement of retained earnings, balance sheet, and statement of cash flows.
- Keeping financial statements updated on a regular clip helps businesses develop, prepare for the future, and better identify their capital needs.
Income Statement
The income statement, also known as aprofit and loss statement, is important because it shows the overall profitability of your company for the time period in question. Information on sales revenue and expenses from both your accounting journalsand thegeneral ledgerare used to prepare the income statement. It shows revenue from primary income sources, such as sales of the company's products, and secondary sources, like if the company sublets a portion of its business premises.
Note
The income statement also shows any revenue during the time period in question from assets, such as gains on sales of equipment or interest income.
The income statement also shows the business's expenses for the time period, includingits primary expenses, expenses from secondary activities, and, finally, losses from any activity, including current depreciation. One thing to note about the depreciation shown on the income statement is that it only accounts for depreciationover the time period in question, not the total depreciation of an item from the time the asset was acquired.
The bottom line of the income statement is net income or profit. Net income is either retained by the firm for growth or paid out as dividends to the firm's owners and investors, depending on the company'sdividend policy.
Statement of Retained Earnings
Thestatement of retained earningsis the second financial statement you must prepare in the accounting cycle. Net profit or loss must be calculated before the statement of retained earnings can be prepared.
After you arrive at your profit or loss figure from the income statement, you canprepare this statement to see what your total retained earnings are to date and how much you’ll pay out to your investors in dividends, if any. This statement shows the distribution of profits that are retained by the company and which are distributed as dividends.
As the name suggests, the amount of retained earnings is the profit retained by the firm for growth, as distinguished from earnings that are distributed to shareholders as dividends or to other investors as the distributed share of profits.
Balance Sheet
No financial statement would be possible without the balance sheet. The balance sheet is the financial statement that tracks the firm's financial position at a given point in time, typically the last day of the accounting cycle. It’s a statement showing what your business owns (assets) and what it owes (liabilities). Your assets must equal your liabilities plus your equity or owner's investment. You have used your liabilities and equity to purchase your assets. Thebalance sheetshows your firm's financial position with regard to assets and liabilities/equity at a setpoint in time.
Entries on a balance sheet come from the general ledger, and the format mirrors the accounting equation. Assets, liabilities, and owners' equity on the last day of the accounting cycle are stated.
Note
The general ledger is the centerpiece of your accounting system—every financial transaction your firm undertakes is recorded in chronological order via debits and credits,
Entries on a balance sheet come from the general ledger, and the format mirrors the accounting equation. Assets, liabilities, and owners' equity on the last day of the accounting cycle are stated.
A note about depreciation: In contrast to the depreciation shown on the income statement, the depreciation shown on the balance sheet -- which is a snapshot of the company at the end of the accounting cycle -- is the total accumulated depreciation from the day the item was acquired to the present.
Statement of Cash Flows
Even if your company is turning a profit, it may be falling short because you don't have adequate cash flow. The cash flow statement compares two time periods of financial data and shows how cash has changed in the revenue, expense, asset, liability, and equity accounts during these time periods.
The statement of cash flows must be prepared last because it takes information from all three previously prepared financial statements. The statement divides the cash flows into operating cash flows, investment cash flows, and financing cash flows. The final result is the net change in cash flows for a particular time period and gives the owner a very comprehensive picture of the cash position of the firm.
The statement of cash flows shows the firm’s financial position on a cash basis rather than an accrual basis. The cash basis provides a record of revenue actually received, from the firm's customers in most cases. The accrual basis shows and records the revenue when it was earned. If a firm has extended billing terms, such as 30 days net, 60 days 1 percent, these two methods can produce substantially different results.
Frequently Asked Questions (FAQs)
What are retained earnings?
Retained earnings refers to the net profit of a company after it makes its dividend and other shareholder payments—earnings which are, therefore, "retained" by the company.
What goes into a financial statement?
Financial statements are summary-level documents that provide details about a company's financial position at a given point in time. Typically a balance sheet, cash-flow statement, and income or profit and loss statement are included.
