Understanding Financial Statements is a comprehensive guide that explains the purpose and importance of financial statements, how to read them, and their relevance for entrepreneurs and investors.
If you're running a business, it's important to understand your financial statements. These documents can give you insights into your company's financial health and performance. However, they can be complex, so in this blog post we'll break down the basics of financial statements and what you should look for.
What is a financial statement and what purpose does it serve businesses and investors alike?
Being an entrepreneur or investor requires keeping track of one's money, and a financial statement is the perfect way to stay on top of your finances. A financial statement is a document that outlines how much money has been earned, spent, invested and saved. It provides valuable insights when it comes to assessing the financial health of a business or individual. Financial statements can help businesses and investors plan for future financial stability and growth by giving them an accurate snapshot of their current finances. By tracking information in this manner over time, entrepreneurs and investors are able to make more informed decisions about their money and ensure their investments are working towards their long-term goals.
The three types of financial statements – balance sheet, income statement, and cash flow statement – and how they work together
If you're an entrepreneur or investor, the three types of financial statements: balance sheet, income statement, and cash flow statement are incredibly important for you to understand. Each of these reports ultimately provides insight into a company's finances and can give investors valuable information concerning their investments. The balance sheet gives an overview of the value of a company's assets, liabilities, and equity at a given point in time. The income statement details revenue minus expenses over a particular period like a quarter or year, while cash flow statements display all inflow and outflow transactions made during a period such as investments into that business. By looking at these statements together, one can gain a comprehensive understanding of how well their investment is performing financially.
How to read a balance sheet – assets, liabilities, and equity
If you're an entrepreneur or investor, understanding how to read a balance sheet can be invaluable. It's a crucial tool for understanding your own financial status, and equally serves to give potential lenders and investors an insight into your business. Balance sheets report the total value of assets, liabilities, and equity owned by a company. By tracking and analyzing these items, you can calculate whether you're in the red or black on any given day. To stay successful over the long haul, carefully considering asset purchases is essential; too many means potentially incurring debt quicker than income can pay it off—which could spell trouble for any entrepreneur or investor. Knowing how to read your balance sheet and keeping up with regular analysis will ensure that you understand where your money goes and where it'll get you in the future!
Balance Sheet
As of December 31, 2020
Assets:
Cash and Cash Equivalents: $1,000,000
Accounts Receivable: $500,000
Inventory: $200,000
Prepaid Expenses: $100,000
Property and Equipment (net): $750,000
Liabilities:
Accounts Payable: $300,000
Accrued Expenses: $200,000
Long-term Debt: $600,000
Equity:
Common Stockholder Equity: $1,150,000
Retained Earnings: $350,000
Total Assets: $2,550,000
Total Liabilities and Equity: $2,550,000
How to read an income statement – revenue, expenses, net income
As an entrepreneur or investor, reading an income statement is key to understanding the overall financial performance of a company. While there are several different components that come together to form an income statement, the primary components include revenue, expenses, and net income. Revenue is what a company earns from delivering goods or services in exchange for payment. Expenses are any fees paid to keep up operations such as salaries and rent. Net income is calculated by subtracting total expenses from total revenue and is essentially the profit or loss you can expect when it’s all said and done. Knowing how to read an income statement can help one make more informed decisions when it comes to investing in a business or industry.
Example of an Income Statement:
This income statement shows the total revenues and expenses for ABC Enterprises from July 1st to December 31st of the current year.
Revenues:
Sales revenue was the primary source of income for ABC Enterprises, totaling $4,000,000. This included sales from products such as computers, software, and other related items.
Expenses:
Total expenses for ABC Enterprises were $3,400,000 including salaries and wages ($1,600,000); rent and utilities ($700,000); advertising ($200,000); office supplies and materials ($300,00); miscellaneous expenses ($200,000).
Net Income:
After subtracting total expenses from total revenues, ABC Enterprises had a net income of $600,000 for the period.
How to read a cash flow statement – operating activities, investing activities, financing activities
Reading a cash flow statement is an invaluable skill for any entrepreneur or investor. Cash flow statements help us to understand the financial health of a business, by showing its inflows and outflows of cash over a period of time. Operating activities, investing activities and financing activities are the three sections that make up the cash flow statement. Operating activities include all regular business operations, such as sales, overhead costs and taxes paid. Investing activities includes any expenditure to purchase or improve fixed assets or investments in other businesses. Lastly, financing activities involve the receipt or payment of money from sources outside of the company such as creditors and shareholders. A thorough understanding of all three major components will enable an entrepreneur or investor to accurately interpret company performance and diagnose potential issues with cash flow.
Cash Flow Statement
For the period ending December 31, 2020
Operating Activities:
Cash receipts from customers: $1,000,000
Cash payments to suppliers and employees: $800,000
Cash payments for taxes: $50,000
Net cash provided by operating activities: $150,000
Investing Activities:
Cash payments for the purchase of fixed assets: $200,000
Cash payments for investments in other businesses: $500,000
Net cash used by investing activities: $700,000
Financing Activities:
Cash received from creditors: $150,000
Cash received from shareholders: $100,000
Cash payments for dividends: $50,000
Net cash provided by financing activities: $200,000
Total Net Cash Flow: $(350,000)
The analysis of a cash flow statement provides an entrepreneur or investor with valuable information to make more informed decisions about its investments in a company. The net cash flow amount for the above example is $(350,000), which means that the company has used more cash than it has generated over this period of time. This can be an indication of financial trouble, and warrants further investigation to understand why this may have occurred. By understanding your cash flow statement you'll have a better understanding of the overall financial health of your business, and be able to make more informed decisions on where to direct your money.
By reading and understanding both income statements as well as cash flow statements, entrepreneurs and investors have the necessary tools to make more informed decisions about their investments. This data can be used to assess current performance, diagnose potential problems, and plan for the future. When used correctly, financial documents like income and cash flow statements can provide valuable insight into a business’s financial health.
The importance of understanding the income statement and cash flow statement cannot be overstated, as they are essential tools for any investor or entrepreneur when considering investments in a business. By being able to read and interpret both documents, you will be better equipped to make informed decisions about how to maximize profits and minimize risks.
Key takeaways from reading financial statements
Balance Sheet
As of December 31, 2020
Assets:
Cash and Cash Equivalents: $1,000,000
Accounts Receivable: $500,000
Inventory: $200,000
Prepaid Expenses: $100,000
Property and Equipment (net): $750,000
Liabilities:
Accounts Payable: $300,000
Accrued Expenses: $200,000
Long-term Debt: $600,000
Equity:
Common Stockholder Equity: $1,150,000
Retained Earnings: $350,000
Total Assets: $2,550,000
Total Liabilities and Equity: $2,550,000
Income Statement
For the Year Ended December 31, 2020
Revenue: $5,000,000
Cost of Goods Sold: $1,500,000
Gross Profit: $3,500,000
Selling, General and Administrative Expenses: $1,200,000
Operating Income: $2,300,000
Interest Expense: $100,000
Income Before Taxes: $2,200,000
Income Tax Expense: $360,000
Net Income: $1,840,000
Cash Flow Statement
For the Year Ended December 31, 2020
Net Cash Provided by Operating Activities: $2,500,000
Net Cash Used in Investing Activities: ($1,200,000)
Net Cash used in Financing Activities: ($1,300,000)
Net Increase/Decrease in Cash: $0
By looking at these financial statements together, one can get a comprehensive understanding of the company's overall performance and make decisions accordingly. This is an important tool for investors to keep track of their investments and plan for future success. The three types of financial statements are all interconnected and can provide valuable information in order to make sound decisions. By using these documents, one can set realistic goals for their investments and ensure that their money is well managed. Additionally, the information provided by these statements can be used to identify any potential problems or areas of improvement. With a clear picture of how your finances are being managed, you can make better decisions and more accurately plan for your future.
The information from these financial statement documents can also be used to gauge the overall performance of a company over time, which is important for investors looking to invest or stay invested in a particular business. By tracking their performance and judging the company's ability to generate and use cash, investors can make more informed decisions when it comes to their investments. Additionally, these documents provide insight into the financial health of a business that can be used in determining its value and worth as an investment. By closely monitoring balance sheets, income statements, and cash flow statements, investors and entrepreneurs alike can get a better understanding of the company's financial condition and make more informed decisions about their investments.
Overall, balance sheets, income statements, and cash flow statements serve as important tools for investors to use in order to make the best decisions with regard to their investments. By closely studying these documents, one can gain invaluable insights into a company's financial health and performance, allowing them to make more informed decisions that can ultimately lead to success. Keeping up with regular financial statement analysis is an essential part of any investor's portfolio management strategy. By understanding the information contained in these documents, investors and entrepreneurs alike can ensure that their money is well managed and used for maximum advantage.
Understanding financial statements is an invaluable tool for the entrepreneur or investor. Whether you are keeping tabs on your own business's finances or studying to make an investment, having the knowledge of how to read and utilize these documents can help a great deal in maximizing any return on investment. Being able to interpret your company's financial statements can show areas of improvement as well as possible risks, enabling efficient decision-making. Taking time to learn the language of financial statements could prove incredibly rewarding for any savvy entrepreneur or investor!
Thanks for reading! We hope this guide was helpful in explaining what financial statements are, what purpose they serve, and how to read them. This knowledge will come in handy whether you’re managing your personal finances or evaluating a business as an investor. Do you have a favourite financial statement? Let us know in the comments below. And don’t forget to subscribe if you found this article helpful.
Founder & Managing Director of Trailyn VC funding pre-seed diverse deep tech founders.
Founder & CTO at Trailyn Ventures, helps investors and companies understand emerging technology.
Host of Female VC Lab Podcast, insightful conversations on the journey of Female VCs, Investors, GPs and LPs.
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