What do entrepreneurs need to understand about basic financial statements?
At this year’s Startup Alleghenies Finance Bootcamp, Dr. Wei-Chung Wang, and Joey DiGangi (the CEO and COO of W.D. Strategies, respectively) were featured as speakers. The goal of their presentation was to help small businesses understand the application and impact of their financial statements.
Here are the key points they covered.
What are the basic financial statements you need to evaluate?
There are 3 basic financial statements that companies will need to evaluate. By analyzing these records, you can get a better overview of your financial decisions and determine a better path forward. These 3 statements are:
- Income Statement
- Balance Sheet
- Cash Flow Statement
An income statement provides an overview of revenues, expenses, net income, and earnings per share over a year or quarter. A complete income statement should contain the following items:
- Operating Revenue (revenue earned from selling products or services)
- Non-operating revenue (revenue earned from interest, rental income, partnerships, or advertisements)
- Primary (business activity expenses)
- Secondary (interest paid on debts or loans)
- Typical (wages and utilities)
Your income statement provides a lot of context regarding your favorability in the market, and how efficiently you’re running your business. If your gross profit is high, then that suggests that your product or service is valuable in the market.
If your expenses are high and even eclipsing your profits, then it could be that your business is running inefficiently, or your business model is unsustainable. By analyzing your income statement, you can determine the viability of your business in its current state.
A balance sheet provides an overview of a company’s assets, liabilities, and shareholder equity at one point in time, typically at the end of a reporting period.
Relating back to personal finance, your household may want to periodically review your financial standing. How much debt you have, your retirement fund, other savings, and the assets you own. In a business context, this review would come with the help of your balance sheet.
Your business assets will be represented by your cash, equity, and any liquid or illiquid assets. Business liabilities will include things like your accounts payable, accrued expenses, and any short-term loans for supporting your operations. Shareholder equity is determined by calculating your total assets minus your total liabilities.
Cash Flow Statement
A cash flow statement establishes how well a company generates cash to pay its debt obligations, fund its operating expenses, and fund investments.
With your cash flow statement, you should have records of operating activities, investing activities, and financing activities.
Your operating activities will be a record of any cash flow occurring through business purposes such as net income from sales or money spent on new inventory. Your investing activities are related to any cash flow involved in long-term investments, such as purchasing equipment for your continuing operations and scaling. Financing activities are in reference to things like equity and debt insurance. If you have any loans, dividends paid or stock repurchases, they will be recorded as financial activities.
For small businesses, the income statement will be your most important financial record. However, the cash flow statement is also important to determine how well your company can manage your debts, and how well you can generate cash.
Measuring Financial Health and Stability
Ultimately, financial statements analysis helps you more effectively evaluate the financial health and stability of your business.
For small businesses, using your income sheet alongside other financial statements will help you analyze your revenue, gross margin (Gross Profit/Revenue), and Operating Margin (Operating Profit/Revenue). By observing this data, you can determine the viability of your business idea. If the numbers show that your current model is unsustainable, you can strategize to eliminate operational inefficiencies and identify what areas of your business deserve more investment.
Working with W.D. Strategies
Our team is experienced helping organizations of all sizes develop strong financial strategies. If you’d like to meet with our team to discuss your revenue position, expansion strategy, or other topics, get started by booking an introductory consultation today: