Financial statements show the financial status of your company. Monitoring the financial health of your business can make the difference between failure and success. For example, properly scrutinizing financial statements will stop you from spending money that you do not have and also let you know when you can deploy funds to take your business to the next level.
There are three primary financial statements: the balance sheet, the income statement and the cash flow statement. The balance sheet demonstrates the basic accounting equation: Assets = Liabilities + Owner's Equity. Assets include everything of value that a business owns or is owed, and liabilities are what a business owes. Owner's equity — the balance left over after you subtract liabilities from assets — is the owner's share of the business. The income statement, also known as the profit and loss statement, shows the profitability, or lack thereof, of a business over a set period. The cash flow statement converts finances from accrual basis to cash basis and measures the flow of cash in and out of the business.
Because financial statements help you to see a snapshot of your company's financial position, they are decision-making tools. Financial statements show business trends, the rate at which you are collecting receivables, the rate at which you are paying creditors and any cash flow problems. For example, accounts receivables reports show who is paying on time, 30 days late, 60 days late and 90 days late. Use this financial statement to determine which customers are in good standing, are in need of collection efforts or have uncollectible open invoices (if an invoice has not been paid within six months, after collection efforts, this is probably an uncollectible debt). Accounts payables reports let you know what is owed to whom and when. You can also generate reports to let you know what your inventory levels are and the value of the inventory. You can generate a report to answer almost any question you have about your business that relates to what you own, what you owe and how much money your company makes. These are questions you need answered as you make strategic decisions on how to make your business successful.
Businesses often need credit as a part of their strategy to remain financially viable. Businesses apply for business loans, business credit cards and credit terms with a vendor. In almost all situations, the lender will ask to see a balance sheet and run your credit report to decide whether to loan you credit. A balance sheet will show a creditor how much debt you are carrying and how much money is flowing in and out of your business. In addition to the financial statements you hand over, an internal accounts payable report helps you to pay your bills on time and keep your company's credit score high so you remain a good credit risk.
You need financial statements to calculate your quarterly state and federal tax obligations. State tax obligations include sales and annual taxes. A sales report that separates taxable sales from non-taxable sales will give you the information you need to pay the state the sales taxes you collected from customers. Federal tax obligations include payroll-related taxes and annual taxes. A payroll liability report will outline all your payroll-related obligations, not only to the federal government but also for benefits. If you are ever audited, you must be able to provide documentation of the information reported in your tax filings. Acceptable documentation is financial statements, beginning with the primary financial statements and any additional statements auditors' request. You must be able to back up the statements with hard records such as receipts and pay stubs. To prepare both state and federal annual taxes, you begin with the primary financial statements. You may find that you need to run additional reports to generate the specific information you need to fill out your tax forms.