Financial data from your
small business firm, you, as the owner, would be flying blind.
Even if the financial end of
things is not your favorite part of your business and you intend to outsource
as much of it as possible, you still have to understand it. Why? Because you
have to understand the output you receive from your accountant or other
financial professional in order to operate your business. For example, if your
accountant tells you that your profit is a Million naira for the year, you must
understand what went into allowing you to making that.
You may not have to know as
many details as the accountant, but you certainly have to understand the big
picture.
Learning the Basics
It's best to start with the
basics in order to understand your financial position. Maybe you've been
schooled in finance and accounting and, if so, consider this a review. If not,
then here we go on a short course in understanding and analyzing your financial
position.
The first thing you have to
get up to speed on is the financial statements that you or your financial
professional will generate for your business firm. These financial statements
will help you determine your firm's financial position at a point in time and
over a period of time as well as your cash position at any point in time. Many
small businesses fail because the owner loses a grip on the firm's financial
position. If you understand financial statements, that won't happen to you.
The Income Statement
The income statement is also
called the profit and loss statement. It is the major statement for measuring
your firm's profitability over a period of time. You develop the income
statement in a step-by-step process starting with the amount of revenue you
have earned. Then you subtract each item your firm has expensed to see what
your profit or loss is after each is deducted. You can prepare income
statements for a short period of time like a month, if you need that type of
information. For tax purposes, you can extend that out and develop your income
statement for the tax year.
How to Prepare an Income
Statement
How to Prepare the Statement
of Retained Earnings
The Statement of Retained
Earnings is the second financial statement you prepare in the accounting cycle.
After you arrive at your profit or loss figure from the income statement, you
prepare this statement in order to see what your total retained earnings to
date are and how much you will pay out to your investors in dividends, if any.
Total retained earnings are then transferred to the balance sheet.
How to Prepare the Statement
of Retained Earnings
The Balance Sheet
The balance sheet is a
statement showing what you own (assets) and what you owe (liabilities and
equity). Your assets must equal your liabilities (debt) plus your equity
(owner's investment). You have used your liabilities and equity to purchase
your assets. The balance sheet shows your firm's financial position with regard
to assets and liabilities/equity at a point in time.
How to Prepare an Balance
Sheet
Statement of Cash Flows
Even if your company is
turning a profit, it may be falling short because you don't have adequate cash
flow. It is just as important to prepare a Statement of Cash Flows as it is to
prepare the income statement and balance sheet. This statement compares two time
periods of financial data and shows how cash has changed in the revenue,
expense, asset, liability, and equity accounts during those time periods.
The statement divides the
cash flows into operating cash flows, investment cash flows, and financing cash
flows. The final result is the net change in cash flows for a particular time
period and gives the owner a very comprehensive picture of the cash position of
the firm.
How to Prepare a Statement of
Cash Flows
These four financial
statement are prepared at the end of the accounting cycle and should be
prepared in this order. Information from the Income Statement comes from the
revenue and expense accounts on the general ledger and information for the
Statement of Retained Earnings comes from the Income Statement and the dividend
account.
The Balance Sheet is prepared
next and the information is taken from the asset, liability and equity accounts
on the general ledger as well as from the Statement of Retained Earnings. Last,
the Statement of Cash Flows is prepared from all the previous financial
statements.
Financial statement can be
prepared for a company for any length of time and at any point in time. Some
companies prepare financial statements monthly to keep a tight handle on the
financial position of the firm. Other companies have a longer accounting cycle.
Financial statements must be prepared at the end of the company's tax year.
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