Financial statements are the building blocks of any well run company.
They can help you to manage and grow your business – if they’re accurate, regularly updated and you use them effectively.
They can reassure investors both current and future and they are essential for getting the best deal on rates if you’re borrowing to invest and grow.
In this article, you’ll learn about the basics of financial statements, why they’re important for your business, how using them can lead to making better business decisions.
Here’s what we cover:
- What are financial statements?
- Why financial statements are important for businesses
- How to use financial statement data to make better business decisions
- How using financial statements can help you grow your business
- Final thoughts
What are financial statements?
In these uncertain times, with the aftermath of the pandemic and lockdown still evident, and Brexit, war in Europe, rising inflation and increasing prices of raw materials, it’s more important than ever that businesses keep on top of their finances.
This is where these comprehensive, accurate financial records can help.
Essentially, these documents are an official record of your company’s financial activities and its financial position.
The aim is to show clearly and concisely the business activities and financial performance of a company.
These essential business tools typically include the balance sheet, the profit and loss account (also known as the P&L or income statement) and a cash flow statement at a minimum.
The balance sheet gives an overview of your business’s assets, liabilities, and the shareholders’ equity at a particular time.
The profit and loss account shows the income and expenditure over a set period, and this is used to calculate the company’s net income or profit.
Finally, the cash flow statement measures how well your company generates cash to pay its debts, its operating expenses and any investments.
These essential representations of a company’s finances are often used by Revenue, accountants and banks plus other lenders to get an accurate picture of the financial position of your company for the purposes of tax.
They’ll also be essential if you’re looking to borrow money or you’re talking to investors.
And if you come to sell your business, the buyer will certainly want to see them.
Why financial statements are important for businesses
The more accurate, timely information you have about your business, the better you can manage it – and handle any risks and threats that it might face.
These documents allow everyone including senior managers, the finance department, HR, sales and others to make better informed financial decisions.
They can, for instance, decide where to invest and where to reign in expenditure.
If you have shareholders (or may have them in the future), they’ll want to use these statements to understand your company finances, so they can hold the board to account, if required, and to decide whether to stay invested.
This detailed information about a company’s financial situation can show when it risks moving into the red but they can also reveal the most profitable periods.
They provide an important comparison with previous years that will enable you to understand the overall trajectory of your business.
They can show how much the business is spending to service its debts and how well positioned it is to repay those debts. It can also show which products or services are most profitable and which are underperforming.
With larger companies, valuation ratios help determine the correct value or price for a company’s shares as well as helping shareholders and others to understand the dividend pay-out ratio and forecast the future dividends.
Specifically, the balance sheet is important because it shows your company’s debt in comparison to its equity.
The sales, expenses, losses and profit figures on the profit and loss account can help investors in your business to evaluate past performance and estimate cash flows in the future.
The cash flow statement is important because by revealing the way cash moves in and out of the business, you, your investors and others can check on whether your business has enough cash to pay for its operating expenses, and any ‘rainy day’ costs.
Financial statements can help to make preparing your accounts quicker and easier when the time comes during the financial year.
They can also be useful if you decide to sell your business, as any buyer will want to see detailed financial statements going back a few years – as well as those looking forward with projections based on solid assumptions.
How to use financial statement data to make better business decisions
Your financial statements can help you measure the basics, such as your debt in relation to your assets and your income compared to outgoings.
They can help you to decide where and how much to invest and whether to increase your liquidity – your available cash – by selling assets.
You can also use them to calculate and even reduce your tax liability (an accountant or tax adviser can help you here).
Financial statements are useful for supporting decisions on which projects or initiatives to launch, and which aren’t by helping you to calculate the return on investment (ROI) that they’ll generate.
You should be able to adjust certain figures – such as the initial investment in the project, its time period or the price of the resulting products or services – as part of your calculations to work out the most efficient and profitable option, assuming there is such a thing.
You can also use these vital documents to manage your budgets by tracking actual spending against estimated expenses income versus expenditure.
Sharing them among your teams can improve collaboration on projects.
Having these detailed financial records helps you to track your net profit over months, quarters and years, which in turn is useful for managing stock, pricing, discounts and expenses.
You can often use this information to compare your performance with the industry average or even with other players in the market.
Measuring time periods for accounts receivable (the amount of time that it takes for you to get paid after you’ve sold your goods and services) in relation to accounts payable days (how long you normally take to pay your suppliers) is another useful outcome.
How using financial statements can help you grow your business
If you want to grow your business, this detailed, accurate and regularly updated information found in your financial statements is essential for bringing in new investment.
Similarly, if you’re planning to borrow money from a bank or an angel investor, they’ll almost certainly want to see recent, comprehensive and accurate details about your business’ financial situation.
Being able to show high-quality records could possibly lower your risk profile and therefore earn you a better interest rate if you’re borrowing funds from a lender.
The same is true if you’re looking to recruit new shareholders to increase your pool of capital and broaden the leadership’s management experience.
This detailed financial information can enable you, your board and your accountant to anticipate tax payments early and manage them in terms of your cash flow. They can also be useful for proper tax planning.
Making mistakes in business can be costly and waste time.
Having detailed, accurate and financial information can mean you’re less likely to make these errors because you’ll have the correct information to base your decisions on.
By tweaking figures in your statements, you can see the results of various actions and permutations of income and expenditure before you carry them out. Ensuring that everyone making projections and decisions has these statements is important.
These statements of your finances need to be forward looking as well as historic.
Of course, knowing your revenues, costs and outgoings over the past few years is important but you also need to be able to make projections.
Detailed plans showing a variety of scenarios over the coming years will help you and your teams to plan for the future.
Moving beyond traditional spreadsheets and using smart accounting software, which might involve keeping this and all of your financial information in the cloud can help.
This will allow you to keep your records constantly updated and to share them in real time with other stakeholders within your business.
The sooner you start, the more years of financial records you’ll accumulate.
And this longevity is particularly useful if you’re applying for loans, appealing to investors or looking to sell your business.
Accurate, timely financial statements are essential for any successful business. Not only do they tell you what’s going on currently, but they allow you to make projections and explore hypothetical scenarios.
And, in today’s fast moving and unpredictable business environment, that’s more important than ever.
Recommended Next Read
How to use the power of compounding to boost business performance
Subscribe to the Sage Advice newsletter
Join 1.5 million subscribers and get the best business admin strategies and tactics, as well as actionable advice to help your company thrive, in your inbox every month.