Understanding Financial Documents

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Right now is a great time to take a look at your financial statements and make sure you understand the state of your business. There are three main types of financial statements that are officially recognized under the U.S. Generally Accepted Accounting Principles. Each statement gives you deeper insight into a specific part of your company’s financial performance. Together, these three documents can help owners, managers, lenders, and investors make good and well-informed business decisions.

Income Statement

A simple record of the revenue and expenses from your company, the income statement tells you at a glance about profits and losses. The most important number is your net income. Your net income is the income remaining after all your expenses, including taxes, have been paid.

Another number to keep an eye on is the company’s gross profit. This is the money earned after subtracting the costs of goods sold from the revenue. Make sure that you are including the total cost of goods from the direct labor and materials to the manufacturing overhead costs of making the product.

Your income statement will also give you the number of sales, general and administrative expenses, payroll, marketing, and the support of making the product or service offered by your company. Keep a close eye on your general and administrative costs. Generally, these should remain mostly fixed. If the ratio of those costs compared to revenue increases, your business might be slowing down.

Balance Sheet

A record of all your company’s assets, liabilities, and net worth, your balance sheet gives you a quick snapshot of your company’s overall financial health. Your assets will usually be listed in order of liquidity and any current assets (like accounts receivable) should be convertible to cash or expensed within a year. Long term liabilities are any payment obligations that extend beyond the current fiscal year.

Your balance sheet must balance, so your total assets need to equal total liabilities plus net worth (equity). If your net worth is negative, it might signal financial distress. Some other red flags to watch out for include:

  • Current assets growing faster than sales
  • Deteriorating ratio of current assets to current liabilities

Statement of Cash Flow

The cash flow statements will tell you all the money coming in and going out. Cash inflows include selling products, borrowing, or selling stock and cash outflows are operating costs, capital equipment investments, and paying off debt.

Cash flows will be organized into three sections: cash flows from operating, financing, and investing activities. Ideally, a company wants to generate enough cash to fully cover expenses.

Understanding the Data

The most successful companies understand the ratios and trends of these three documents. Need help understanding them? Contact MCK today to discuss how we can help you with your finance and accounting needs.