Accounting is probably the most important component of the entire business cycle. Accounting helps ensure that all of a business’s assets, liabilities, and equities are accounted for, helping them continue operating and making smarter decisions.
Furthermore, accounting also helps ensure that a business remains in good legal standing. Failing to keep up with taxes and follow all corresponding tax laws is one of the most common ways businesses end up failing, or even facing legal penalties.
Hiring an outsourced ecommerce accountant can help your business ensure it is making the right financial choices and is operating within the law. Outsourced ecommerce accountants are certified public accountants who help businesses of all kinds manage and update their books. This includes not only monitoring accounts receivable and accounts payable, but also generating key financial statements on a regular basis.
Whether your business plans to hire an outsourced accountant or wants to do all bookkeeping on your own, there are a few financial statements that you will want to familiarize yourself with. Financial statements are not only used for internal decision-making, but they are also used by other relevant parties, such as lenders, investors, regulators, and more.
Below, we will discuss the financial statements that every business needs. By taking the time to understand why these statements are important and learn about the information they each contain, you can prepare your business to make better financial decisions.
Table of Contents
The Balance Sheet
The Balance Sheet is perhaps the most important financial statement a business owner will ever encounter. The balance sheet is a “snapshot” that represents what the business owes and owns at any given point in time. Contrary to other financial statements, the balance sheet is constantly changing. In this sense, the balance sheet should be considered an “active” financial statement.
The balance sheet will include three distinct categories. In the left-hand column, the business will list all of its assets (including cash), which accounts for everything that the business owns. In the right-hand column, the business will list all assets and liabilities. Liabilities include all current and future expenses that the business owes (including anticipated taxes). The other component of the right-hand column, owner’s equity, is a reconciling column that represents the difference between assets and liabilities. Assets should always equal liabilities plus equity—if this is not the case, then there is an error with the balance sheet.
The balance sheet can be used by many different parties. Lenders will want to look at the balance sheet to determine how much leverage your business has and determine how much they can comfortably lend you. The balance sheet will also be useful in the event of a merger, a sale, an audit, and various other financial events.
The Income Statement
The Income statement is also extremely important. Unlike the balance sheet, the income statement is effectively a summary of how your business performed over a specific period of time. Usually, income statements will be issued on an annual, quarterly, and monthly basis (especially for companies with active investors).
The income statement accounts for all revenues and expenses accrued over a specific period of time. In some ways, the income statement might represent the “accounting version” of the bank statements that you receive every month. The revenue column should include all incoming cash flows, along with any corrections needed for previous statements. The expenses column accounts for all outgoing cash flows, including expenses.
The income statement will be used to determine whether a business is profitable. If revenues are greater than expenses—something that all businesses hope to eventually achieve—this yields a net profit. If expenses are greater, that means the company is operating at a loss. Using the income statement makes it easier for business owners and fractional CFOs to identify potential opportunities for saving money, growing the business, or otherwise improving operations.
The Statement of Cash Flow
The Statement of Cash Flow (also known as the cash flow statement) helps business owners determine whether they have the amount of cash needed to continue operating smoothly. In some ways, the statement of cash flows resembles the statements mentioned above but specifically focuses on cash—the most liquid of all assets a business might be holding.
On the statement of cash flow, all activity is placed into one of three categories: cash from operating activities, cash from investing activities, and cash from financing activities. Using these distinct categories makes it easier for business owners to identify potential bottlenecks, as well as financial opportunities.
The Statement of Owner’s Equity
The Statement of Owner’s equity, according to one legal expert “shows the business’ retained earnings—the profit kept, or retained, within a business rather than distributed to owners or shareholders—both at the beginning and at the end of a specific reporting period.”
Like the income statement, the statement of owner’s equity represents a summary, rather than a snapshot. Usually, businesses will strive to maximize owner’s equity when possible, but they might also use this equity to invest in the overall growth of the business (such as opening a second location). But when all else is equal, having equity is undoubtedly desirable.
The Importance of Creating and Maintaining Financial Statements
As any experienced accounting firm will tell, these are the most vital financial statements a business will need to have. Internally, having accurate and updated financial statements will put business owners in a position where they can make decisions that are in the enterprise’s best interest. They will also be able to manage all legal obligations, plan for the future, and develop a functioning budget.
Externally, there are many other parties that will be interested in these financial statements. Lenders, investors, the government, and potential buyers will all want to see that your books are sound and that your business is in good financial shape. In other words, these statements offer the best way for outsiders to truly understand the state of your business.
Because these statements are so fundamentally important for business owners, most will turn to a certified public accountant (CPA) for guidance.