Financial Statements Basics

Learn the basic principles of business financial statements

Even if your business is a small one, it's a good idea to prepare financial statements. Businesses that are independent entities (LLCs, corporations, etc.) must prepare an annual financial report and answer to stockholders, so financial reports are even more important for these companies. You must prepare these statements properly; they are the only way to communicate your company's true financial standing.

Generally Accepted Accounting Principles (GAAP) are the rules set forth by the U.S. Securities and Exchange Commission, and it's imperative that you follow these principles when creating any of your business financial statements. There are four main types of statements to familiarize yourself with:

1. Balance sheets: This type of corporate financial statement shows the assets and liabilities of a company. It also shows owner's equity.

2. Income statements, also known as profit and loss statements (P&Ls): This type of statement indicates net income.

3. Statements of cash flow: This type financial statement shows all the business's cash inflow and outflow.

4. Statements of retained earnings: Public company financial statements should include this type, but it's not necessary for privately held businesses.

 

Create one of the most important aspects of financial statements basics: the balance sheet

The balance sheet is one of the two main financial statements used to measure the health of a business. It categorizes all assets and liabilities and shows the net worth of the company. It also includes owner's equity. The general equation used in the balance sheet is Assets = Liabilities + Shareholders' Equity. Industry professionals refer to the balance sheet as a snapshot, since it only represents these things at a single point in time, usually at the end of the fiscal year.
Try: Find out how to create a balance sheet at Virtual Advisor, which includes a sample balance sheet. The sample at Vertex42 will give you an idea of what your balance sheet should look like.

Show your profits and losses by creating an income statement

The income statement is the other main financial statement you'll need to know about. The P&L lists all sources of income as well as every expense category. Net income is calculated from these figures. The income statement represents a certain period of time; for example, revenue and expenses from January through March. You can create this statement for any time period, although quarterly statements are the most common.
Try: Download one of the financial statement forms at docstoc; you can use it as an example to make your own or fill it out as is. TD AMERITRADE offers a nice explanation for the different components of the income statement.

Attain investors with the cash flow financial statement

The statement of cash flows is actually very simple. It states the cash flow into and out of the business for a certain period of time (quarterly or annually, usually). Information is divided into operating activities, investing activities, financing activities and supplemental information (income taxes and interest paid). The main point of the statement of cash flows is to show investors that the company has significant liquidity.
Try: Check out the different aspects of the cash flow statement at IBM. The sample at Business Resource Software will help you figure out how to create your own.

 

• The statement of retained earnings shows how much net income a company retains within it after dividends are paid to stockholders. It is the fourth financial statement governed by GAAP but is not used unless a company is publicly traded. The equation to calculate retained earnings is Ending Retained Earnings = Beginning Retained Earnings - Investments - Dividends Paid + Net Income.
• If you need some help making your financial statements, there are quite a few financial statement software programs you can choose from. Some of them are meant to be used on a regular basis and will automatically generate financial statements. Basic programs will at least include a template you can use.

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