Overview
If you want to evaluate your business, there are three core financial statements you can use. A Profit and Loss Statement will outline changes in accounts over a set period, while a Balance Sheet shows a company’s assets and liabilities at a specific point in time. Cash flow statements highlight cash management and shows how well a company generates cash. Analyzing these statements can show a company’s financial strength and overall well-being.
Balance Sheet
Balance Sheets report a company’s assets, liabilities, and shareholder equity at a specific point in time. This report shows what a company owns and owes at a single moment, as well as shareholder investments. It can provide the basis for computing rates of return and evaluate a company’s capital structure. Comparing balance sheets between different periods can show financial trends over a period of time.
The structure of a balance sheet equates assets by the sum of liabilities and shareholder equity. A company’s assets can include cash, inventory, property or prepaid expenses. Liabilities are any credit cards, bank loans, accrued expenses or other financing. Any retained earnings, which is an accumulation of the business past profits, are shareholders equity.
Analysts can use balance sheets to calculate financial ratios. They can show a company’s debt-to-equity ratio in addition to the acid-test ratio. Debt-to-equity shows how a company’s debt compares to its assets. The acid-test ratio compares a company's cash and accounts receivable to its current liabilities. This can help determine a company’s risk by assessing whether it’s borrowed too much, if the assets are not liquid enough or if their cash does not meet their current demands. Balance sheets are also beneficial in securing capital or retaining talent by showing the company is in good health.
Profit and Loss Statement
If a company wanted to outline its revenue, costs and expenses over a specified period of time, they can have a Profit and Loss Statement put together, otherwise known as an income statement. This is typically done either monthly, quarterly or by fiscal year. This report tells a company how much they spend and earn over the specified time period, showing either the company’s ability or inability to generate profit and tells them if they need to either reduce costs, increase revenue or both to reach their desired profit.
Profit and Loss Statements can be presented on a cash or accrual basis. The cash method recognizes revenue and expenses when cash is actually paid or received. This method is commonly used by smaller companies. The accrual method of accounting tracks on a transactional basis. It records revenue as it is earned and accounts for future money it expects to receive. For example, if a company has delivered a product or service but hasn’t received payment yet. Liabilities are also accounted for even if the company hasn’t paid for the expense yet.
Comparing Profit & Loss Statements over different accounting periods will show investors and analysts the profitability of a company. Changes over time can be more meaningful than just the numbers themselves. Also, comparing statements with a similar companies can further evaluate a company’s well-being.
Cash Flow Statement
Cash Flow Statement’s summarize the amount of cash, or cash equivalents, entering and leaving a company. It highlights cash management and compliments the balance sheet and income statement.
The structure of a cash flow statement is broken down into three categories. Operating activities show operating expenses like sales receipts, salary paid to employees, and payments such as interest, income tax or supplier costs. Investing activities show any sources and uses of cash from investments, such as loans or purchases of assets. The final section is financing activities which show sources of cash from investors and banks as well as how the shareholders are paid.
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