Creating Financial Statements

What are financial statements? Financial statements are reports that summarize important financial accounting information about your business. There are three main types of financial statements: the balance sheet, income statement, and cash flow statement. Together, these statements provide you—and outside people like investors—a clear picture of your company’s financial position. Common Types of Financial Statements 1. Balance Sheets A balance sheet is a snapshot of your business finances as it currently stands. It tells you about the assets you own, and liabilities (i.e., debts) you owe, at a particular point in time. How often your bookkeeper prepares a balance sheet for you will depend on your business. Some businesses get daily or monthly financial statements, some prepare financial statements quarterly, and some only get a balance sheet once a year. For example, banks move a lot of money, so they prepare a balance sheet every day. On the other hand, a small Etsy shop might prepare a balance sheet every three months. This sheet contains information about the company's liabilities, assets, and shareholders' equity, and is based on this accounting equation: Shareholders’ equity is a term that refers to the net worth of a company. It reflects the amount of money that would be left if all assets were sold and all liabilities paid. This money belongs to the shareholders. Assets are anything the company owns that has quantifiable value. This may include physical property (vehicles, real estate, unsold inventory, etc.), as well as non-physical property (patents, trademarks, etc.). Liabilities refer to money the company owes to a debtor. This may include outstanding payroll expenses, debt payments, rent and utility payments, money owed to suppliers, taxes, bonds payable, and more. Sample Balance Sheet Walkthrough Let’s say you run a food cart selling ice cream. At the end of June, you get a balance sheet from your bookkeeper. It looks like this: June Balance Sheet Not bad! It’s summer, your busiest time of year. One month passes. At the end of July, your balance sheet shows this: July Balance Sheet Nice. You’ve added $1,000 to your retained earnings by saving more cash, even though your liabilities haven’t changed. This is useful information. But it’s not the full picture. Does your balance sheet tell you… …how much ice cream you sold? No. …how much cash you received? No. …how much it cost you to make the ice cream you sold? No. …how much you spent on expenses? No. This is where the income statement comes in. 2. Income Statements An income statement is a report that a company generates to communicate how much money the company has earned over a period of time. It shows you how much you made (revenue) and how much you spent (expenses). Revenue: how much you earned from selling product or service Cost of Goods Sold (COGS): the total amount it cost you to make the product or service Gross Profit: tells you how profitable your products are Gross Profit = Revenue - COGS Operating Expenses: the cost of running your business, not including COGS Net Profit: tells you how profitable your business is Net Profit = Gross Profit - Operating Expenses Sample Income Statement Walkthrough Suppose we have an income statement for July that looks like this: July Income Statement You sold $1,000 worth of ice cream. If ice cream costs $4 each cup, that means you sold 250 ice cream cups. What does the income statement tell us that the balance sheet doesn’t? With this info, you know how many more ice cream cups you have left in inventory - and how many more you should be prepared to make next July. What else? There are two expenses here besides interest expense: electricity and maintenance. Looking back over your income statements, you’ll be able to see which months you spend more on electricity, and roughly how often you need to pay for maintenance on your ice cream cart. More importantly, you’ll be able to plan ahead for more expensive months (electricity-wise) and know roughly how much money to set aside for maintenance. You can only get this kind of information from the income statement. But what’s missing? Does your income statement tell you… …how much money you have in the bank? No. …how much money you owe to your credit card company? No. …how much equity you have in the business? No. …how much money you had one month ago vs. six months or a year ago? No. To get that info, you need snapshots of your business’s finances. You get those from the balance sheet...or you may need a third type of statement. 3. Cash Flow Statements A cash flow statement is a report that details how a company receives and spends its cash. These are also called cash inflows and outflows. A company can only operate when it has the money to cover its expenses. Cash flow reflects a company’s ability to operate in both the short- and the long-term, and is used by investors, creditors, and regulators to determine whether a company is in good financial standing. Cash flow statements are typically split into three sections: Operating activities, which details cash flow generated from the company delivering upon its goods or services, including both revenue and expenses Investing activities, which details cash flow generated from the buying or selling of assets, such as real estate, vehicles, and equipment (using free cash and not debt) Financing activities, which details cash flow from both debt and equity financing Here’s an example cash flow statement, using our ice cream stand from before: Why are financial statements important for small businesses? Arizona Microcredit Initiative (AMI) has consulting and microloan support for yourself and your business. If you have any more questions, you can schedule an appointment today through https://www.azmicrocredit.org/schedule-a-consultation-1 or reach out to us at info@azmicrocredit.org. Return Home Continue to Expand Playbook

Creating Financial Statements