Understanding accounting, the language of finance and business, is crucial for all business owners and entrepreneurs. When starting a business, learning how to read financial statements is as important as managing any other task. It is of utmost importance to understand the statements, rather than continuing to invest money blindly.
With time, the business will hopefully expand, and bookkeeping with other companies, tax authorities, and customers will have to be made. The business bookkeeping must always be counted and rechecked. These transactions of business and records are maintained using various financial statements and accounting terms.
A successful entrepreneur has a strong understanding of the tools of accounting and finance. Grasping the knowledge of interpreting account statements allows an entrepreneur to be able to accomplish principal tasks.
- Entrepreneurs can evaluate and predict the future of business. They can work with other like-minded entrepreneurs to make business plans accordingly and work to achieve their goals.
- They can use their time, energy, and money more effectively by making important decisions to help the business grow.
- They can review business plans and respond tactically after interpreting accounting statements to prevent loss to the company.
The following are the three most important financial statements in business bookkeeping.
Income Statement
An income statement is divided into sales and expenses.
Sales include the selling of goods and services to customers and receiving monetary payments in return.
Expenses include:
- The purchases made on behalf of the company
- The employees that were hired for running the business and their salaries
- Bank loans that were received on behalf of business for investment or other purposes in the company
- Tax expenses that were paid as income taxes
Balance Sheet
A balance sheet is a collective form of statements that are made based on all transactions made in the past. It categorizes assets and liabilities.
Assets can be fixed assets as well as cash in the bank. It includes the raw materials, work in progress that will yield profit, finished goods, and the value-added tax. Value-added tax is a tax on the amount by which the value of an article has been increased at each stage of its production or distribution.
Liabilities comprise the payments that have to be paid by the company. It includes the gross amount of money that has to be paid to suppliers. Value-added tax liability is money paid to tax authorities for the sales that were done, and debt is the amount of money that has to be paid by the company to the lenders.
A balance sheet needs an end balance.
Cash Flow Statement
Cash flow statements show the money that flows in and the money that flows out.
A cash flow sheet includes the investing and financing cash flow. Investing cash flow is the invested cash in the fixed assets of the business. The financing cash flow describes the money in capital from what was either received from the investors or paid to the investors.
A third but essential form of cash flow is “operating cash flow.” It explains the money flowed-in and flowed-out to the running business.
These three cash flows are added and show the change in the overall amount of cash.
Conclusion
The above three financial statements are interrelated. As the income and expense statements increase, the assets and liabilities in the balance sheet will increase. The assets and liabilities will decrease per the cash flows from the cash flow statement.
Entrepreneurs need to know important information in credit analysis of their business. Understanding and correctly interpreting financial and accounting statements can work as a litmus test for entrepreneurs.
Accounting is the language of business. Interpreting this language will help entrepreneurs determine their value of assets. They will be able to calculate profitability and also estimate the risks in the assets of the company. They can understand the company’s financing sources. Entrepreneurs must realize investment, credit analysis, and profitability. The entrepreneur’s ability to identify debt and equity shows insight into the value of a company.
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