Understanding Financial Statements

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Coins-1015125_1920In Financial Accounting – Reporting for those outside the business, the 3 most important financial statements, relevant for budding entrepreneurs are:

  1. The Statement of Financial Position or the Balance Sheet
  1. The Statement of Income or The Profit & Loss Statement
  1. The Statement Of Cash Flows.

The Balance Sheet shows the business's assets, the liabilities, and the equities of a business. It is a 'snapshot' of the business economic resources at a certain date. That is why when you see one, it says something like, The Statement Of Financial Position as at dd/mm/yyyy.

Unlike a Balance Sheet that is a 'snapshot' of economic resources, the Profit and Loss Statement is a summary of the flows of earned revenues and incurred expenses of a business for a period of time. That is why when you see one, it says something like: Profit & Loss Statement for the year 200X.

The Statement of Cash Flows summarizes the 'cash' effects of the activities of a business for a period of time. These activities can be operating, investing and financing. The keyword that I would like to emphasize in the above definition is the word 'cash'. It only records activities that involved the transfer of cash.

I can summarize the above even further:

  1. Your Balance Sheet shows you what you own and how you acquired them (borrowed from others or contributed by you).
  1. Your Profit And Loss shows you how much you are expending each period and how much you are earning.
  1. The statement of Cash Flows summarizes the exchange of cash in your operating, investing and financing activities.

I personally feel that for most freelancers, when starting a small business, attention should be placed on your Profit and Loss statement because that is your record of how much income is coming in and how much expenses is going out. Take a look at the revenue items there to know which activity is bringing in money and take a look at the expense items to see which ones are costing you the most and ask yourself whether those expenses are really necessary. Are there ways in which you could cut your costs?

Costs are what any entrepreneur has to control at the start of every business. No cost item should go by unnoticed or unmonitored. Their existence must be justified. Every dollar counts. Every dollar that gets tied up in one thing is a dollar that could otherwise be used somewhere else.