How To Read And Understand Financial Statements As A Small Business

Summary

In 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

00:00

📊 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.

05:01

💼 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.

10:02

💸 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.

Keywords

💡Financial Statements

Financial statements are formal records that provide a comprehensive overview of a company's financial activities. They are essential for assessing a business's financial health. In the video, three main types are discussed: the balance sheet, income statement, and cash flow statement, each serving a unique purpose in summarizing a company's financial position. The script emphasizes the importance of understanding these statements for making informed business decisions.

💡Balance Sheet

A balance sheet is a snapshot of a company's financial situation at a specific point in time, detailing its assets, liabilities, and equity. It is structured to reflect the fundamental equation: assets equal liabilities plus equity. The script uses Disneyland's balance sheet as an example to illustrate how assets owned by the business are balanced against what it owes and the value of the business to its owners.

💡Assets

Assets are resources owned by a company that have value and can provide future economic benefits. The script categorizes them into current assets, which are liquid and can be quickly converted to cash, and fixed assets, such as property and equipment. Assets are a critical component of the balance sheet, reflecting the economic strength of a business.

💡Liabilities

Liabilities represent the debts or obligations that a company owes to external parties. In the script, they are divided into current liabilities, which are due within one year, and long-term debt. Liabilities are a key element of the balance sheet, indicating the financial obligations that must be settled by the company.

💡Equity

Equity, also known as owner's equity, refers to the residual interest in the assets of a company after deducting liabilities. It consists of investments made by the owners and the retained earnings of the business. The script explains that equity is part of the balance sheet equation, highlighting its importance in reflecting the net worth of a company.

💡Income Statement

The income statement provides a summary of a company's revenues, costs, and expenses over a specific period, culminating in the calculation of net profit or loss. It is referred to as the 'bottom line' in the script, emphasizing its role in determining a company's profitability. The income statement is a crucial tool for evaluating a company's operational performance.

💡Revenue

Revenue, or sales, is the income generated from a company's regular business activities. It is the starting point of the income statement, as described in the script. Revenue is a critical financial indicator that reflects the demand for a company's products or services and its ability to generate income.

💡Cost of Revenue

Cost of revenue, also known as cost of goods sold (COGS), represents the direct costs attributable to the production of the goods or services a company sells. The script explains that it includes the costs of materials and labor directly tied to the creation of the product, but not overhead costs like rent or salaries for administrative staff.

💡Net Profit

Net profit, as mentioned in the script, is the final figure on the income statement after all revenues and expenses have been accounted for. It represents the profit remaining after all costs have been deducted from revenues, indicating the company's overall financial success and efficiency in generating earnings.

💡Cash Flow Statement

A cash flow statement tracks the flow of cash in and out of a business over a period of time. Unlike the income statement, which is based on accrual accounting, the cash flow statement provides a real-time picture of the company's liquidity. The script differentiates it from the income statement by focusing on actual cash transactions, which is vital for understanding a company's immediate financial capacity.

💡Liquidity

Liquidity refers to the ability of a company to pay off its short-term obligations with its current assets. The script discusses the current ratio, which is calculated using the balance sheet's current assets and current liabilities, as a measure of a company's liquidity. High liquidity implies that a business can meet its immediate financial obligations without difficulty.

💡Bookkeeping

Bookkeeping is the process of recording and maintaining financial transactions of a business. It is fundamental to producing accurate financial statements. The script mentions bookkeeping as a service offered by Bench, which can be particularly valuable for businesses that do not have the resources or expertise to maintain their financial records in-house.

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