How To Read And Understand Financial Statements As A Small Business
Summary
TLDRIn this educational video, Aidan from Bench Accounting explains the importance of financial statements for business decision-making. He covers the three main types: the balance sheet, income statement, and cash flow statement, detailing their structure and how they interrelate to provide a comprehensive view of a company's financial health. He also discusses key financial ratios and the significance of understanding cash flow, offering templates and suggesting the use of professional bookkeeping services for accurate financial tracking.
Takeaways
- 📈 Financial statements are essential reports that summarize a business's financial information.
- 📚 There are three main types of financial statements: the balance sheet, income statement, and cash flow statement.
- 💼 The balance sheet provides a snapshot of a business's finances, detailing assets, liabilities, and equity at a specific point in time.
- 🏦 Assets include valuable items owned by the business, such as cash, office furniture, inventory, and patents.
- 💳 Liabilities are debts owed by the business, such as credit card debt, mortgages, and accrued expenses.
- 💰 Equity represents the remaining value of the company after subtracting liabilities from assets.
- 🔍 The balance sheet equation is assets = liabilities + equity, ensuring the financial statement is balanced.
- 💡 The income statement shows how much money a business has spent and earned over a specific period, calculating the net profit.
- 💻 The income statement is composed of sections including revenue, cost of revenue, gross profit, operating expenses, operating income or loss, taxes, and net income.
- 💸 The cash flow statement reveals the actual cash transactions of a business, differentiating it from the income statement which may include non-cash transactions.
- 🏢 The cash flow statement is divided into cash from operating activities, investments, and financing activities, providing a clear picture of cash inflows and outflows.
Q & A
What are financial statements and why are they important for a business?
-Financial statements are reports that summarize crucial financial information about a business. They are important because they provide a comprehensive view of a company's financial health, helping business owners and stakeholders make informed decisions.
What are the three main types of financial statements mentioned in the script?
-The three main types of financial statements are the balance sheet, income statement, and cash flow statement.
Can you explain the purpose of a balance sheet?
-A balance sheet provides a snapshot of a business's financial situation at a specific point in time, showing the assets owned, liabilities owed, and the equity of the company.
What are assets and how are they categorized in a balance sheet?
-Assets are valuable resources owned by a business, such as cash, office furniture, inventory, and patents. They are categorized into current assets (cash or cash equivalents) and fixed assets.
What is the difference between current liabilities and long-term debt?
-Current liabilities are debts that a business owes within the next 12 months, while long-term debt refers to obligations that extend beyond 12 months.
How is equity represented on a balance sheet?
-Equity represents the residual interest in the assets of the company after deducting liabilities. It can be in the form of common stock or retained earnings.
What is the balance sheet equation and why is it significant?
-The balance sheet equation is Assets = Liabilities + Equity. It is significant because it shows that the value of assets must always equal the sum of liabilities and equity, ensuring the accuracy of the balance sheet.
What does an income statement reveal about a business?
-An income statement reveals how much money a business has spent and earned over a specific period, allowing the calculation of net profit or the bottom line.
Can you describe the main sections of an income statement?
-The main sections of an income statement include revenue, cost of revenue, gross profit, operating expenses, operating income or loss, taxes, and net income.
How is the net profit calculated on an income statement?
-Net profit is calculated by subtracting the cost of revenue, operating expenses, and taxes from the gross revenue, resulting in the bottom line or net income.
What is the primary purpose of a cash flow statement?
-The primary purpose of a cash flow statement is to show how much cash has entered and left a business over a specific time period, reflecting the actual cash transactions and the liquidity of the business.
How does the cash flow statement differ from the income statement?
-While the income statement shows the amount earned and spent based on accrual accounting, the cash flow statement shows the actual cash transactions, providing a clearer picture of the business's cash position.
What are the three main components of a cash flow statement?
-The three main components of a cash flow statement are cash from operating activities, cash from investing activities, and cash from financing activities.
Why is it important to reconcile the ending cash on a cash flow statement with the actual bank account?
-Reconciling the ending cash on a cash flow statement with the actual bank account ensures the accuracy of the financial reporting and verifies that all transactions have been accounted for correctly.
Outlines
📊 Introduction to Financial Statements
Aidan from Bench Accounting introduces the concept of financial statements, explaining that they are reports summarizing a business's financial information. He outlines the three main types: the balance sheet, income statement, and cash flow statement, and their roles in providing a comprehensive view of a company's financial health. Aidan also mentions that templates for these statements can be found in the description, and he begins a detailed explanation of the balance sheet, including its components: assets, liabilities, and equity.
💼 Understanding the Balance Sheet and Income Statement
The balance sheet is described as a snapshot of a business's financial status at a specific point in time, detailing the assets owned and the liabilities owed. It is broken down into current and fixed assets, current and long-term liabilities, and equity, which is the residual value after liabilities are subtracted from assets. The balance sheet equation, assets equal liabilities plus equity, is highlighted, and the importance of the balance is emphasized. Aidan then transitions to the income statement, which tracks the money spent and earned by a business over a period, allowing for the calculation of net profit. The income statement's structure, including revenue, cost of revenue, gross profit, operating expenses, operating income or loss, taxes, and net income, is explained, with a focus on Apple's income statement as an example.
💸 The Importance of Cash Flow Statement
The cash flow statement is introduced as a tool to track the actual cash transactions of a business over a specific time period, distinguishing it from the income statement, which records accrual-based revenue and expenses. The statement is divided into three parts: cash from operating activities, cash from investing activities, and cash from financing activities. Each part is explained with examples, such as the Toronto Raptors' cash flow statement, which includes adjustments for accounts payable and the purchase and sale of equipment. The importance of matching the ending cash balance with the bank account to ensure accuracy is stressed. Aidan offers a template for creating a cash flow statement and encourages viewers to consider professional bookkeeping services like Bench for regular financial statement updates.
📈 Conclusion and Call to Action
In the conclusion, Aidan summarizes the importance of understanding and regularly reviewing financial statements for making informed business decisions. He suggests that while accounting professionals can create these statements using software, those less comfortable with accounting may benefit from hiring a bookkeeper or using Bench's services to ensure accurate and timely financial reporting. The video ends with a reminder of the resources available in the description and a wish for success in the viewer's entrepreneurial journey, emphasizing the role of proper bookkeeping in financial management.
Mindmap
Keywords
💡Financial Statements
💡Balance Sheet
💡Assets
💡Liabilities
💡Equity
💡Income Statement
💡Revenue
💡Cost of Revenue
💡Net Profit
💡Cash Flow Statement
💡Liquidity
💡Bookkeeping
Highlights
Financial statements are reports that summarize important financial information about a business.
There are three main types of financial statements: the balance sheet, income statement, and cash flow statement.
A balance sheet provides a snapshot of a business's finances, detailing assets, liabilities, and equity.
Assets include valuable items a business owns, such as cash, office furniture, inventory, and patents.
Liabilities are debts owed, such as credit card debt, mortgages, and accrued expenses.
Equity is the remaining value of a company after subtracting liabilities from assets.
The balance sheet equation is assets equal liabilities plus equity.
The liquidity of a business can be measured using the current ratio, which is current assets divided by current liabilities.
The income statement shows how much money a business has spent and earned in a specific period.
Net profit, or the bottom line, is calculated by subtracting all expenses from revenue on the income statement.
Gross profit is the revenue minus the cost of revenue, indicating the profitability of products and services.
Operating expenses include all other costs of running a business, such as utilities, rent, and support staff.
Operating income or loss is calculated by subtracting operating expenses from gross profit.
The cash flow statement shows how much cash entered and left a business over a specific time period.
Cash flow statements are crucial for businesses using the accrual basis of accounting to understand cash realities.
Cash from operating activities includes core business transactions, such as buying and selling goods.
Cash flow from investments covers non-core business transactions, like purchasing equipment.
Cash from financing activities includes money invested by the owner and loans taken out or repaid.
The total change in cash from all activities, plus the beginning cash, equals the ending cash.
Bench Accounting offers bookkeeping services and financial statement templates to help businesses manage their finances.
Transcripts
hey there
aidan here from bench accounting today
we're going to talk about financial
statements
what they are how to read them and how
to actually get
value from them for making real business
decisions
let's start with the definition
financial statements
are reports that summarize important
financial information about your
business
there are three main types of financial
statements
the balance sheet income statement and
cash flow statement
we'll look at what each of these three
statements do and how they work together
to give you a full picture of your
company's financial health
if you need a template for the balance
sheet income statement
and cash flow statement you can find
links to those
in the description below let's start
with the balance sheet
[Music]
a balance sheet is a snapshot of your
business finances
as it currently stands it tells you
about the assets you own
and liabilities aka debts that you owe
at a particular point in time balance
sheets are broken up
into three general categories assets
liabilities and equity here's what it
looks like
this one happens to be the balance sheet
for disneyland
assets are anything valuable that your
business owns
including cash office furniture
inventory
patents etc sometimes they're broken up
into current assets and fixed assets
like you see here current just means
it's cash
or cash equivalent something you can
sell quickly
next we have liabilities liabilities are
debts you owe to other people
these can be things like credit card
debt mortgages
and accrued expenses such as utilities
taxes or wages owed to employees
like assets they're normally split into
current liabilities that you owe
within the next 12 months and long-term
debt
beyond 12 months the last category
is equity equity is the remaining value
of the company
after subtracting liabilities from
assets
equity can come in the form of common
stocks like when you buy stock in a
company like apple
or in the form of retained earnings
which is the amount of
net income left over for your business
after you've paid out any dividends to
shareholders
now here's where the whole balance part
of the balance sheet comes in
the value of the asset section will
always
balance with the liabilities and equity
section
that's the balance sheet equation assets
equal
liabilities plus equity
so you can see on the disneyland balance
sheet the value of the assets
is the exact same as the liabilities
plus equity
that's how you know they prepared the
balance sheet right
that's a quick overview of the balance
sheet big businesses
like banks prepare a balance sheet every
day
small businesses like a brand new etsy
shop might only prepare a balance sheet
every three months
it all depends on how many assets are
moving in and out of your business
now what can you really learn from a
balance sheet
tons of things for one you can measure
the liquidity of your business with the
current ratio
which is current assets divided by
current liabilities
this tells you if you'll be able to pay
off your debts in the next 12 months
and there's lots of other useful ratios
you can calculate
using just your balance sheet next let's
talk about the income statement
the income statement tells you how much
money your business has spent
and how much it has earned in a specific
period
that lets you calculate your net profit
otherwise known as your bottom line
the reason it's called the bottom line
is because net profit
is at the bottom of your income
statement here's what an income
statement looks like
this one is from apple it has six main
sections
revenue cost of revenue gross profit
which is revenue minus cost of revenue
operating expenses operating income or
loss taxes and other non-operating
expenses
and net income let's go through what
each section means
we'll make it quick revenue is how much
money you want
pretty basic cost of revenue or cost of
goods
sold is how much money it costs to make
and distribute your product or service
this doesn't include things like the
cost of your bookkeeper
or the cost of rent those are operating
costs
gross profit is your revenue minus cost
of revenue
essentially how profitable your products
and services are
operating expenses are all the other
costs of running a business
utilities rent support staff who aren't
making or distributing your products
etc you can see for apple they also
include research and development here
since the r d team isn't exactly making
products
they're just doing research that may or
may not lead to a new product
operating expenses are also known as
overhead
operating income or loss is your gross
profit
minus operating expenses this shows you
how profitable your whole business is
how efficient your business
is at making money you might have a nice
gross profit
but you spend way too much on rent and
office snacks
so overall you're losing money after you
calculate your operating income
or loss you need to take into account
things that are somewhat out of your
control
mainly taxes after you've subtracted
taxes from your operating income or loss
you get the bottom line your net income
that's how much money you walk away with
after you've subtracted
everything else the value of the income
statement
is a little more obvious to most people
compared
to say the value of the balance sheet
it shows you if you're making money if
your business is profitable or not
that is super useful more than that it
shows you if you're spending too much
money producing your products
or if you're spending too much money on
overhead
the cost of running your business more
generally
you'll want to consult your income
statement regularly
if you want an income statement of your
own you can click the link in the
description where you'll find a simple
income statement template
of your own created by our expert
bookkeepers here at bench
if you don't want to do your own
bookkeeping and make your own income
statements
you can check out bench we'll do your
bookkeeping for you
and send you an income statement every
month
anyway on to the last financial
statement your cash flow statement
the cash flow statement tells you how
much cash entered
and left your business over a particular
time period
you might ask isn't that the same as the
income statement
no the income statement shows you how
much you spend
and how much you made the cash flow
statements show you what the cash
reality
of your business is this is most
relevant
for businesses that use the accrual
basis of accounting
let's say your income statement says
that you made ten thousand dollars in
march
but your cash flow statement says that
you only made five thousand dollars in
cash
what's going on well it could be that
you sent out
two invoices to clients for five
thousand dollars each
if you're using the accrual system of
accounting you would record that ten
thousand dollars as revenue in march
even though you haven't gotten paid yet
then
one client pays you but the other client
is late
your income statement would say ten
thousand dollars but your cash flow
statement would say five thousand
dollars
it's super important to know what the
cash situation of your business is
if you don't have cash you can't pay
bills even if you have accounts
receivable money on the way to you
this is what a cash flow statement looks
like this is one from the toronto
raptors
the cash flow statement has three parts
the first
is cash from operating activity this is
all the core business activity buying
stuff and selling stuff
below that you see adjustments things
like accounts payable
and luxury tax taxes aren't from
operating activity
but they still come out of our cash so
we subtract it
accounts payable technically isn't a
cash transaction
at all however on the income statement
it's marked as an expense
even though it's money that hasn't been
paid out yet
so we add it back into the cash flow
statement so we get an accurate picture
of how much cash we actually have today
next is cash flow from investments in
your business
so not the regular buying and selling of
your core business
but things like equipment work vehicles
etc
in the case of the toronto raptors here
they bought an ice bath tub
and a hyperbaric chamber for athletes to
recover after games
and they also sold a hyperbaric chamber
the last category is cash from financing
activities
this includes money the owner invested
in the business
as well as taking out and repaying loans
on the rapture statement we see there
was an owner's draw
which means the owners withdrew 225
000 from the business this basically
means
they paid themselves if you add all
three categories together
you get the total change in cash
if you add the beginning cash to the
total change in cash
you get the ending cash and for good
measure
you check your ending cash against what
your bank account actually says to make
sure
you added everything up correctly if you
want to create your own cash flow
statement
you can download our template in the
description below just plug in your
numbers
and you have a basic statement you can
use to analyze your cash situation today
that's the end of our financial
statements crash course if you're an
accounting pro using accounting software
you can create these statements yourself
if you're less comfortable with
accounting you're probably going to want
to hire a bookkeeper to do it for you
if you don't have a bookkeeper today
check out bench
we'll do your bookkeeping for you and
send you financial statements every
month
so you can make smart business decisions
and stay on top of your finances
that's it from us here at bench good
luck on your entrepreneurial journey
and happy bookkeeping
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