Importance of Financial Statements
Why are financial statements so important? Does it matter if the information used to create them is accurate or not? Ask your tax advisor. Ask your banker. Ask an investor. Accurate financial statements matter. Preparing financial statements with accurate information in a timely manner is a critical component to running a successful business.
The most common types of financial statements are the Balance Sheet, Income Statement, and Statement of Cash Flows. The Balance Sheet displays the financial position of the company at a specific point in time. It reports the assets owned and the liabilities owed as a figurative snapshot at a point in time. The difference between assets and liabilities is what you “own.” What you own called “equity”— also known as the owner’s investment in the business.
The Income Statement reports the results of operations for a period of time. This is not a cash flow statement. The best income statement is recorded on the accrual basis. For instance, revenues are recorded when earned, and not when cash is received. The Income Statement is the record of the operating performance of the business. The bottom line will report net income or net loss, which is revenue minus expenses. It is crucial the chart of accounts be set up correctly and amounts coded properly so the information flows to the appropriate revenue and expense categories.
The Statement of Cash Flow reports the change in cash during a period time. This report shows cash sources and uses, in addition to cash supply. This statement summarizes cash inflow and outflow that has already happened in order to provide the reader with the amount of cash that was made available over a period of time.
In order for financial statements to be useful, they must be prepared on a timely basis. The objective is to provide management with a tool or guide used for running successful operations. This needs to be on a consistent basis using accurate information. Make sure bank accounts as well as other balance sheet accounts are reconciled monthly to ensure all transactions are accounted in the proper periods. Issuing reports in a timely fashion can also help identify adverse trends which in turn, helps pinpoint issues and how the company compares to prior years.
Ratios are also helpful for management or whomever the audience is for quickly determining liquidity, profitability, and leverage of the business. A few key ratios are: The Current Ratio is used to determine short-term assets which can be converted to cash to pay short-term liabilities. The Gross Profit Ratio is used to monitor what portion of sales can be applied to overhead and profit. And the Debt-to-Equity Ratio is used to measure financial leverage and the related risks.
Garbage in is garbage out. Make sure the appropriate information is being used to create financial statements. The end product is used by tax professionals to prepare the tax return and do tax planning, the bank when needing operating funds or loans for expansion, and investors for financial growth or selling opportunities. These all contribute to the many reasons that timely and accurate financial statements are so important to a business.