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Understanding Financial Statements
Understanding financial statements, knowing what they mean and how to use them effectively are crucial to running any business. However, for non-financial professionals, they may be difficult to understand.
We’re here to help break down financial statements into ways that are easy to understand while explaining their importance and the role they play in making informed business decisions.
Here’s what to know:
4 Key Financial Statements
There are many different financial statements you might come across, but the four fundamental ones are:
- Balance Sheet: A balance sheet displays what assets your company owns and how much you owe at the end of the fiscal period. You are using the equation of Assets = Liabilities + Shareholder’s Equity.
- Income Statement: These help you see and understand your business’ profitability. They break down how much your business earns and spends and can be used as a profit-loss or earnings statement.
- Cash Flow Statement: Cash flow statements, or “Statement of Changes,” give you an understanding of how money has moved through your business during the fiscal period.
- Statement of Retained Earnings: This is how you’ll learn your business’ total earnings after any dividends or distributions to shareholders. It will also show the change in your retained earnings account from the opening and closing fiscal periods.
4 Types of Financial Statements
Breaking things down even further, the way a financial statement is prepared or what it is used for also comes with its own level of complexity, validity, and cost.
- Internally Prepared: This is when you prepare the statement internally without the assistance of an accounting professional.
- Compilation: Formerly known as a Notice to Reader (NTR), this is the most basic form of financial statement which a professional accountant prepares for you. It relies entirely on the information you provide, and the accountant does little to no auditing.
- Review Engagement: A review engagement is like a compilation; however, this method does involve some validation or auditing from the professional accountant. Review engagements provide limited assurance.
- Audited Statements: These are thoroughly and heavily audited by the accountant and provide the highest level of assurance that the information in the statement is validated. They are better suited for larger businesses.
So Why Are They Important?
Now that we know the different types and uses of financial statements, what makes them so important?
For starters, they are a vital asset in building up your business and are essential for managing and planning for the future. Financial statements are significant for strategic planning, budgeting, and forecasting things to come.
Keeping an eye on your short-term and annual financial statements will show how well your business is performing along with give insight into valuable trends. It will also allow you to match up your finances with any set targets, budgets, and forecasts.
Everything is Connected
You may better understand balance sheets, income statements, cash flow statements and statements of retained earnings, but it’s important to know they’re all connected.
For example, the changes in assets and amounts owed on the balance sheet are also in the revenues and expenses you find on the income statement. Cash flows give you a better understanding of cash assets, which are also listed on the balance sheet and related to the income statement’s net income.
You can’t learn everything about your business from just one statement. Much like a puzzle, you’ll only see the full picture of your business’ successes and faults when combined.
We Can Help
The team at Mowbrey Gil can answer any questions you might have about your financial statements. Working with our team ensures you have a complete understanding of how to utilize financial statements to help you build your business.
We’d love to hear from you — Contact us today at 780.461.3800.
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