It is always important to keep track of your finances when running a business and whether you have an accountant doing that for you or you are doing it yourself, there are 4 statements that can really help with this process. In this blog we will be looking at the basic statements all businesses should be aware of and making use of. It is important to know that these statements are required to follow certain standards set out by the IFRS (International Financial Reporting Standards). More specifically the “IAS 1 Presentation of Financial Statements” which “sets out the overall requirements for financial statements, including how they should be structured, the minimum requirements for their content and overriding concepts such as going concern, the accrual basis of accounting and the current/non-current distinction”. It is therefore important to understand which financial statements are useful to you and how.
1) Profit and Loss Statement (P&L) otherwise known as the Income Statement
The name of this statement essentially tells you what it is used for and that is to assess whether the company can make a profit or loss by either increasing revenue or reducing costs. The statement does this by providing you with information regarding your company’s revenues, expenses and costs incurred within a specific period of time. It is important to note that there are two different methods of preparing this statement. One of which is the cash method, commonly used by smaller businesses as this is used when cash is received and paid. For example, the company will only record an expense or income in the P&L statement once the money has been paid or received. Whereas with the accrual method, revenue is recorded as it is earned. An example of this would be when a company provides a service and accounts for this income in the P&L statement even if payment has not been received yet. Thus the accrual method is used more often as it leads to more evenly spread revenues and expenses in time, hence providing a better understanding of the company’s finances.
2) Balance Sheet otherwise known as the Statement of Financial Position
A balance sheet is a bit more in-depth and could be harder to understand for those who are uncertain of accounting terminology. It is essentially a summary of what the business owns as well as what it owes. Although it may seem complicated with all the different headings the balance sheet uses a very simple formula, assets on one side which is equal to liabilities plus shareholders equity on the other side. Essentially everything the company owns (assets) is equal to everything the company owes (liabilities and shareholders equity), again as the name indicates, everything should be balanced. This is an extremely important statement as this is what potential investors will use to calculate financial ratios in order to assess the company’s financial position.
3) Cash Flow Statement otherwise known as the Statement of Cash Flow
A cash flow statement is essentially exactly as the name states, it is an understanding of how and where the cash within the business flowed in and out. As with the P&L, there are two ways to prepare this statement, either the direct or indirect method. The direct method is a very detailed way of showing the cash changes over a certain period as it lists every transaction on the cash flow statement. It outlines the changes in cash payments and cash receipts and once this has been listed, the outflow is subtracted from the inflows and the net cash flow is calculated. The indirect method which is less time-consuming and thus used more often takes figures from already existing statements, namely the balance sheet, where the net income of the company is adjusted by adding or subtracting the differences from non-cash transactions. These differences are found in the changes in a company’s assets and liabilities over different periods of time. Additionally, it is important to know that this cash can “flow” within three different categories: operating, investing and financing activities as shown below.
4) Statement of Changes in Shareholder Equity otherwise known as the Statement of Equity
This statement is not as common as the rest as this is mainly used within very large businesses that have copious amounts of investors and shareholders. This statement allows the shareholders to get a clear understanding of what influenced the gains or losses in equity throughout the relevant financial period. Shareholders are able to make more informed, strategic investment decisions as they can clarify retained earnings and identify the par value of common and treasury stocks. The way that this statement is prepared differs from one business to the next however the general layout is as follows:
Opening balance of Equity + Net income – Dividends +/- Comprehensive income = Closing balance of Equity
Financial statements are extremely important as it allows for the evaluation of the company’s performance against competitors as well as the company’s improvement or potential decline. This means that all those involved in the business such as owners and shareholders can assess where the business requires improvement and what needs to remain the same. Finally, financial statements can also aid in attracting potential investors as they can easily see whether or not the company has potential or not.
If you are not sure where to start with the financial statements preparation for your business or worse even, you don’t know whether your business is profitable or not, make sure to book a free consultation with us, where we can assess your current financial processes and make a suggestion on where you can start to gain more clarity for your business financial performance and have the monthly financial statements ready for you to make timely business decisions.
Whether you need help with VAT filing, monthly bookkeeping or budgets and strategies for your business, get in touch with us to see how we can help you grow your business. Have a look at how we have been helping our clients.
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