What Are The Financial Documents Required For Small Businesses?
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Two of the most commonly used words in business are profit and loss. The business’s size and nature may not be necessary here, as the underlying principle of making profits while reducing losses is the fundamental piece that completes the puzzle of the whole business.
But how do businesses keep track of the profit and loss they experience every month?
Recording this profit and loss is embedded in how a business manages its financial documents. While these financial statement documents may be quite complex and varied for larger firms, they are comprised of only a few parts for a small business.
Do you know the reason why small businesses usually fail? They fail because the owners fail to keep tabs on the firm’s cash flows and financial position.
And, of course, when they fail to make proper decisions based on these cash flows and financial positions.
If you own a small business, here is a list of 3 financial documents that are most likely to give you a complete picture of your financial position and where you stand as a business. Knowing the basics of these financial documents will charter a future course of action that will likely benefit your business.
Think of the balance sheet as a snapshot of the current financial position of your business. Although many investors skip the balance sheet part and go straight to the income statement to gauge a company’s monetary worth, the balance sheet is what they should start with. Why? Because balance sheet is a condensed and summarized version of your business’s fiscal health as it contains critical financial information at a given date.
But what does a balance sheet contain, and why is it important?
- Business Assets: Assets are what the company owns at a given time. And this ownership feature is not limited to what the business owns but also what it controls and possesses, such as tangible assets of plant and machinery and intangible assets of patents and copyrights. Both of these items have a small business operating as a registered company. The balance sheet of a small business contains the following components:
- Liabilities: the obligations of a firm or what the firm owes is mentioned in the liabilities section of the balance sheet. It shows what a business owes to its suppliers, customers, banks, etc., and its obligations, such as borrowed loans and payables.
- Owner’s equity: this last component of the balance sheet finally addresses what is left for the owner(s) after the assets that the company possesses are used to pay off the liabilities that the company owes. After all the obligations are paid off, the remaining assets are the owner’s share. And it is up to the owner to decide what to do with these assets, retain them with himself, or re-invest them back into the business.
Think of your income statement as your business’s report card.
While a balance sheet shows a snapshot of your business’s financial position at a fixed date, an income statement (also called a profit and loss) provides an overview of how your small business is doing over time.
An income statement shows a business’s profitability by estimating the expenses and the cost of goods sold. You can calculate the profitability of your business by subtracting your expenses from your total revenues to generate an estimate of profit or loss position.
The bottom line or net profit (or loss) will determine what expenses you should focus on and what costs you should curb as unnecessary. Where a balance sheet shows what you owe to others, an income statement shows how your business is doing in terms of the losses or profits it generates—how much cash is left to grow your business and cover your debts.
When an investor looks at your business plan, he will most probably refer to your income statement to assess your spending and how much you are spending.
Statement of Cash Flows
From a cursory glance, your business might be generating profits, but look closely at your statement of cash flows, and you will find out that’s not the case.
Even if your small business is drawing profits, it might face difficulties managing its cash. This is because money doesn’t necessarily flow into your business the same way that it flows out.
Unlike the balance sheet and income statements, the statement of cash flows compares two consecutive periods, such as the beginning and end of the month, dividing the cash flows into operating, investing, and financial cash flows.
The complete cash picture is displayed in this statement of cash flows, indicating how much cash your small business is generating to stay afloat.
Drawing it up altogether
The three financial statements mentioned above give a complete account of the economic viability of your business, making it easier for you to make decisions based on the numbers contained in these documents.
Usually drawn at the end of each accounting cycle, these financial documents are more than just documents for your firm. They are a means to expand your business if you plan to localize in other markets, and this will be done through the help of a professional localization partner.
Managing a business is not an easy task. But once a company learns to interpret these financial statements accurately and take strategic steps based on them, it will be able to make a worthy “profit” in the market, and only then will it be able to stay ahead of the competition.
Many small businesses burn and fizzle out in their infancy—and the reason is an inability to make decisions based on these financial statements. The real challenge, therefore, is to comprehend and interpret these financial tools to make careful and analytical decisions for your business—irrespective of the nature of your small business.