What is the Importance of Financial Statements for Small Business?

With so many urgent issues competing for your attention, it’s not surprising that few entrepreneurs find or make the time to read their financial statements, specifically, their income statement, balance sheet and statement of cash flows. Another obstacle is a lack of understanding and experience in interpreting them. Even some of the most highly intelligent business owners either don’t understand their financial statements, or they underestimate their importance.

Your business’ financial statements provide vital information about your business’ financial health. For that reason, these statements are incredibly useful for decision making regarding expansion and alternative financing options. They also play an important role in marketing decisions, since this data indicates which of your company’s operations will provide the best return on investment. 

Considering the influence these statements have on business decisions, they should be managed on a regular basis.

What is an Income Statement?
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The income statement measures your business’ revenue sources against its expenses for a designated period and is useful for evaluating your business’ profitability and performance. Some of the major components of the income statement include sales, gross profit, cost of goods sold (e.g. utilities, equipment, repairs, etc.), operating expenses, operating profit, and depreciation. This statement also includes the amount of income earned before paying taxes, along with your business net profit after taxes, or your “bottom line”.

Your income statement provides valuable answers to critical questions; such as, how much was spent to produce or acquire the products/services sold, and how does your business compare to others in the industry? 

If expenses are rising too quickly in relation to gross profits, the income statement allows you to assess which areas you should cut back, along with which areas are driving sales. Ultimately, your income statement provides a comprehensive summary of how much revenue your business made during a reporting period, and how much it spent to produce that income.

What is a Balance Sheet?

The balance sheet captures the state of your business’ financial health at a specific point in time. The key components of this statement are assets and liabilities. The assets section will include a detailed list of what your business owns (current assets and fixed assets). Current assets are assets that can be converted into cash in a year or less (e.g. cash, liquid investments and accounts receivable), while fixed assets cannot be converted into cash within that time frame and are for long-term use (e.g. land, equipment, vehicles, and machinery).

Similar to assets, current and long-term liabilities are separated by the time in which they are due. Current liabilities are obligations of the business that are due within one year (e.g. short-term loans, accounts payables, accrued expenses, and taxes). Long-term liabilities, on the other hand, are not due for at least one year (e.g. bank debt payable outside a 12-month period). As a business owner, the balance sheet is a very informative financial piece that reveals your company’s net worth by finding the difference between its assets and liabilities.

What is a Cash Flow Statement
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One of the most overlooked and perhaps misunderstood statements is a business’ cash flow projection. A cash flow projection provides insight into a business’ anticipated income and expenditures for an upcoming period. If used correctly, the cash flow statement is a powerful tool that allows you to anticipate and plan for potential revenue pitfalls. It provides the information you need to create a strategy for conserving resources, or for seeking financing solutions elsewhere (e.g. invoice factoring or purchase order funding).

The cash flow statement is divided into four categories: net cash flow from operating activities, investing activities, financing activities and net change in cash and marketable securities. Operating activities include those that either generate or require cash (e.g. cash paid to employees, cash collections from customers, interest, and taxes, etc.). Investing activities are discretionary investments made by management and typically consist of equipment purchases. Financing activities are external sources that use and affect your business’ cash flow (e.g. changes in short- or long-term loans and dividends paid). Finally, the total change in cash and marketable securities is determined by the result of the first three calculations. When it comes to running your business effectively, the cash flow statement is the most useful financial management tools you have at your disposal.

What are Some Financial Red Flags to watch out for?

With the valuable information your financial statements provide, you will be equipped with the data you need to identify red flags. For example, the following red flags could signal trouble for your business:

A large list of “other” expenses. 

It isn’t uncommon for businesses to have “other expenses”; these expenses are typically too small or inconsistent to quantify. The efficient management of these expenses involves evaluating these items regularly. If they seem too high, find out what they are specifically and whether they are recurring.

Unstable cash flow. 

Cash flow should move steadily in and out of your business. Excessive or insufficient cash flow can indicate an underlying problem. For example, while a large supply of cash might be the result of accounts being settled, it could also indicate there is less business coming in.

Rising accounts receivable or inventory (in relation to sales).

When cash is tied up in accounts receivable or has been used to secure inventory, it is not generating a return. While it’s important to maintain inventory to fulfill orders, it’s equally important to avoid revenue sitting unsold in your warehouse. Accounts receivable factoring helps solve this problem

Many business owners would be surprised at how much cash they could really collect each year. However, they fail to realize because they fail to closely monitor their financial statements. For example, if they took the time to analyze these statements, they might discover how many weeks’ worth of sales is tied up in accounts receivable.

Imagine how much more your business could accomplish if it had extra cash. Would you hire more staff to help grow sales? Maybe you would invest in new equipment? While the answers will differ depending on your specific business, few entrepreneurs would argue that they can’t use extra capital. The issue is obviously not how you would use it, but how and where to get it.

Trust Security Business Capital

The team of experts at Security Business Capital specializes in helping companies secure the funds they need to operate smoothly, grow their business, and take advantage of opportunities, minus the high-interest rates and costs. SBC’s invoice factoring services, for example, allows you to use unpaid invoices to secure the cash you need quickly and easily, in as little as 24 hours. 

Invoice factoring is successfully used by many different industries, including manufacturing/distribution, business services, transportation, oil and gas, among others. With SBC, there are no hidden fees. There are no monthly minimums, and our clients are not required to factor every customer or every invoice.

To learn more about Security Business Capital’s invoice factoring option or other services, like PO financing, contact SBC for a free quote and/or consultation.