In this next stage, the information from your General Ledger is organized into Financial Reports. Essentially, Financial Reports make your financial information meaningful. They let you view your company's financial health as a whole or in detail. For example, your Income Statement lets you view your income for the year or the month, but it also lets you compare this year's variable expenses to last year's or last month's, helping you monitor your progress and spot any important trends. Or perhaps you'd like to isolate the profitability of a particular product or retail outlet? You can do this easily if you generate the right Financial Reports.
It may be possible to get away without generating Financial Reports when a business is small, but even then it's not advisable. Not only are Financial Reports valuable decision-making tools, they're also your best means of communicating financial information, both inside and outside your business. They keep you informed about the financial health of your business, plus they are standard enough to inform others as well. If you are applying for a bank loan, for example, your loans officer will be able to get a clear picture of your financial health by reading them.
While there are a variety of Financial Reports you can generate for your business, the most important ones are:
Balance Sheets — These can be thought of as a “snap shot” of the financial position of your business. They list what is owed to your business, what is owed by your business, and what your business owns at a given specific moment in time.
Income Statements — These show the financial changes that have occurred in your business over a given time period. In other words, they show how much money your company made (or lost) during that time.
Cash-flow Statements — These monitor the flow of cash through your business. For example, every time you pay cash for a purchase or settle an accounts payable, an outflow of cash is recorded. Every time you receive cash for a sale or a customer settles an accounts receivable, an inflow of cash is recorded. Nothing is more important to the immediate survival of a business than cash. If a business runs out of cash, it will die.
While there are some basic rules to follow when designing your Financial Reports, you still have a fair amount of flexibility concerning their layout. As you go through this section, keep asking yourself, “How can I make this more useful for my business?“
Your Balance Sheet represents the financial state of your business at any given time, typically at the end of your annual accounting period (the end of your fiscal year), and at the end of your interim accounting periods (typically monthly). It represents what you own and what you owe, and as the name implies, it is set up so that both sides are “balanced.”
Following is an explanation and breakdown of your basic Balance Sheet categories.
These are the things your business owns. They include everything of value that belongs to your business, for example, manufacturing equipment, property, cash, raw materials, or inventory.
Items are listed in order of their “liquidity,” in other words, the speed and ease with which they can be turned into cash.
Current Assets (or Short-Term Assets) are cash, or will likely become cash within one year. The basic categories are Cash (and cash equivalent), Accounts Receivable, Inventories and short-term investments.
Fixed Assets are those used by your company during normal operations, but are not intended to be converted into cash during the normal course of business. Typical examples include land, buildings and improvements, machinery and equipment
Other Assets are long-term assets not normally considered part of the daily operations of your business. These include long-term external investments such as securities and intangible assets such as patents, copyrights and goodwill.
Valuation Accounts represent the ongoing loss in value of certain assets due to depreciation, theft, and so forth. Following are some typical examples.
Allowance for Bad Debts represents the estimated losses from your Accounts Receivable. To determine this figure, calculate the amount you estimated to be uncollectible based on the length of time money is owed to you. Your Accounts Receivable Aging Report will help you here.
Shrinkage represents the estimated losses from your Inventory due to theft, price changes, style changes, deterioration and so forth.
Depreciation represents the estimated loss in value of your Fixed Assets, excluding land, due to obsolescence, wear and tear and so forth. Different items will be depreciated at different rates, so speak with your accountant about the pros and cons of your options.
These are your business debts. They include all monies owed by your business.
Current Liabilities (or Short-Term Liabilities) are debts that must be paid within one year. These typically include the Current Portion of Long-term Debt, Short-Term Debt, Accounts Payable and Accrued Payroll. (For example, bank overdrafts, credit extended by suppliers and salaries owed but not yet paid.)
Long-Term Liabilities are your long-term debts, such as the money owed on a 15-year mortgage.
The Owner's Equity is another way of saying Net Worth.
Contributed Capital/Owner's Investment is the original investment the owner(s) made in your business.
Paid-in Capital is all the subsequent capital that has been invested into your business since that time.
Retained Earnings are the Net Income the business has generated (or lost) over the past year, less whatever has been distributed to the investors in the form of dividends.
From an outsider's perspective: Assets = Liabilities + Owner's Equity
From the owner's perspective: Owner's Equity = Assets - Liabilities
Review your Balance Sheets from the past six months.
Timing — You should receive and review these documents regularly. Depending on the size of your business, quarterly may be an adequate schedule. How often do you currently receive and review them?
Do you receive them expediently? The longer you wait to review your financial reports the less up-to-date you are on your financial status, so try to have them available as soon as possible.
Accuracy — Mistakes are annoying, take time and resources to fix, and give you a false impression of your financial status. How accurate are your Balance Sheets?
Detail — Have you included enough detailed information on your Balance Sheet? How detailed should they be for your needs?
Layout/Format — Are your Balance Sheets simple and clear?
Now note any changes you would like to make to your current format.
Update your Balance Sheets with the changes you noted above. If you do not currently have one, now is the time make one.
Your accountant can generate Financial Reports for you, but set up a meeting with him or her first to ensure you end up with reports that work for your business.