Overview of Financial Statements

A cornerstone of understanding financial management involves understanding a few financial statements. There are 3 main financial statements that businesses use to track the health of their business. These statements are the income statement, balance sheet and cash flow statement.

The Balance Sheet

You can think of a balance sheet as a snap shot of your business's financial health. It gives a picture of the relationship between your assets, equity and your liabilities. Managers use this statement to determine both long and short term financial health. For example, the balance sheet alert managers if the business is carrying too much debt in relationship to its assets.

The Income Statement

Where the balance sheet is a snap shot of a business, the income statement shows how capital flows through a business over a period of time. The income statement starts with a company's sales and deducts the various expenses incurred to arrive at a net income (profit) figure. Of all the statements discussed in this course, the income statement is the one people are most familiar with.

The Cash Flow Statement

The cash flow statement shows how much actual cash a business has on hand and projects cash flow balances into the future. The cash flow statement is particularly important for small businesses and entrepreneurs. Healthy balance sheets and income statements are great signs, but the cash flow statement determines whether or not a business survives. It is possible to show a profit on a business's income statement, and still go out of businesses because of a temporary negative cash flow. This is also true of the balance sheet.

When managing working capital the cash flow statement becomes the most important, followed by the balance sheet and then the income statement. We will use the former two statements extensively throughout these sections.

Accounting Software and Statement Generation

We recommend learning as much as you can about your financial statements, but understanding every detail is not mandatory. Not everyone is a CPA, and expecting small business owners to fully grasp all the details of each of their financial statements is not always realistic. Fortunately, many of today's accounting software packages make maintaining accurate and informative financial statements much easier. Modern account software allows business owners to generate the statements above with the push of a button. While these software packages allow business owners to skip the details, it is very important to a general understanding of what each of the statements mean for your company's financial health.

When in doubt about which software to purchase, QuickBooks is always a safe bet. It's is very easy to use, has a great user interface, and is fairly flexible. QuickBooks is great for entrepreneurs that do not have a sophisticated in house accounting department.

If your organization does have trained accounting personnel, they should be able to recommend the proper software for your organization. You can also consult an accountant outside of your company for a software recommendation.