Understanding financial statements

Knowing how to manage your finances will help you make the right decisions for your business.

Financial statements that are produced regularly and correctly will provide key information for the continual improvement of business operations.

There are three major financial statements to understand:

• Profit and loss statement
• Cash flow statement
• Balance sheet

Profit and loss statement

The profit and loss statement (also called an income statement) is a summary of a business' income and expenses over a period of time. It is prepared at regular intervals usually monthly and at financial year end.

Use the Financial statements template (XLS 298.5 KB)  to work out your profit and loss statement. Add as many categories into the spreadsheet as you need, particularly in the sales revenue and expenses area.

Things to remember

• Do a profit and loss statement in order to analyse all income and expense categories.
• Try to do profit and loss statement monthly - you will get a better understanding of your income and costs.
• Recognise areas that need more analysis, and take action before small problems become big problems (e.g. business expenses are increasing so you need to re-price your goods to keep making a profit).

Tip: Learn how to read financial statements, calculate profit and the cost of goods by attending a financial management workshop or seminar.

Cash flow statement

A cash flow statement is a summary of money coming into and going out of the business for a set time period.  It is prepared monthly and at the end of the financial year.

Use the Financial statements template (XLS 298.5 KB)  to work out your cash flow statement.

Types of cash flow

Cash flow is divided into three categories.

Operating activities	Operating activities are the day-to-day results of buying and selling of goods and services. They usually include: receipts from income payment for expenses and employees funding of debtors funding to and from suppliers stock movements.
Investing activities	Investing activities include investments in future business activities, e.g. buying and selling fixed assets. Can include items such as: payment for purchase of plant, equipment and property proceeds from selling the above payment for a new investment proceeds from selling an investment.
Financing activities	Financing activities covers how a business finances itself. Examples include: extra money the owners inject into the business money the business borrows money others borrowed from the business they pay back money the owners take out of the business.

 

Note: Net operating cash flow is the amount of cash that a business has after paying its bills.  If a business has a number of overdue bills, these do not affect the cash flow statement until they are paid in cash. A cash flow forecast will help you measure and monitor how the business is operating.

Things to remember

The cash flow statement can provide helpful warning signals to avoid future financial troubles.

Potential warning signs are when:

• cash receipts are less than cash payments - you are running out of money
• net operating cash flow is an outflow - cash flow is negative
• net operating cash flow is less than profit after tax - you are spending more than you earn.

Balance sheet

The balance sheet is a general snapshot of the financial health of a business on a given day. These are usually completed at the end of a month or financial year.

A profit and loss statement and cash flow statement is needed to do a balance sheet.

Your balance sheet includes the business’:

• assets
• liabilities
• net worth.

Your accountant is probably the best person to prepare a balance sheet. Accounting packages also offer balance sheet reports.

Assets	Assets are the items of value the business owns. They include: cash and stock on hand (inventory) land and buildings equipment and machinery furniture patents and trade marks money others owe the business (debtors or accounts receivable).
Liabilities	Liabilities are what the business owes others outside the business. They include: money owed to suppliers money owed to taxation department (GST, PAYE, FBT etc.) bank accounts that are in overdraft (i.e. you owe the bank money) and/or credit card debt loans to buy capital assets, e.g. a new vehicle.
Ownership equity or net worth	This is the value of the business after deducting what the business owes. A negative figure means the business has debts it cannot pay.

 

Balance Sheet Classifications

‘Current’ and ‘non-current’ classifications are made to assist in monitoring the financial position of your business in regards to assets and liabilities.

Current assets	Items that are likely to be turned into cash within a period of twelve months or less, such as cash in the bank, monies owed from customers (debtors) and stock.
Current liabilities	Funds that must be repaid within twelve months, such as bank overdrafts, credit card debt and monies owed to suppliers.
Non-current assets	Items that will continue to exist in their current form for more than twelve months. These can include furniture and fittings, office equipment, company vehicles etc.
Non-current liabilities	Loans from external stakeholders that do not have to be repaid within the next twelve months.

 

Balance sheet equation

The balance sheet calculation is the value of all the assets of the business, less the value owed to those outside the business (liabilities). This figure equals what the business owner or owners can say the business is worth (equity).

Assets ($73,000) - Liabilities ($28,500) = Equity ($44,500)