Financial statements are key indicators of the health of your business at specific points in the company’s accounting year and on an ongoing basis. Your company’s fundamental success is dependent on a complete understanding of these documents, so we felt that a handy explainer would be useful for anyone wanting to know more.
There are three main types of financial statement that it is important to be aware of:
- Profit and loss
- Balance Sheet
- Cash flow statement
Profit and Loss Statement
Your P&L statement (sometimes called income statement) provides a summary of revenue (company income or turnover, sometimes called “top line”) minus your cost of sales (direct costs related to production or supply) and minus expenses/overhead expenditure (other costs and liabilities such as staff, rent, fees, insurance, marketing, stationery etc.)
This document might also show EBITDA (earnings before interest, tax, depreciation & amortisation) which is basically to take account of other non-operational and non-cash expenses.
The “bottom line”, i.e. the figure showing whether the company is profitable or in the red, is established by taking all the costs of doing business (cost of sales, expenditure and EBITDA) from the revenue.
Whilst the P&L statement shows the profitability of the company over the course of a given period, the company balance sheet is an indicator of the state of your company at a specific point in time. It records;-
- your assets (cash, inventory, accounts receivable i.e. money owed to the company, petty cash, land etc.);
- your liabilities (rent, tax, utilities, debt i.e. money owed to creditors/suppliers, wages & dividends payable);
- shareholder funds (the ‘balance’ of retained company earnings not payed out as dividends).
The shareholder funds are calculated by taking the ‘liabilities’ figure away from the ‘assets’ and is a good indication of the ‘net value’ of the company.
Cash Flow Statement
Your cash flow statement is important as it tells you how much money you have (or expect to have) in the bank after a given period. It shows where the cash is coming from and going to, and this data can be used to assess where costs can be cut or where expenditure may need to be increased.
Here you record;-
- Sales from operations (client paying receivables)
- Investments (changes in assets & liabilities)
- Financing (debt, equity & loans)
It is therefore a bit of a mix between a P&L statement and a Balance Sheet, in that it takes account of cash on hand (assets, also indicated in the balance sheet) but also looks at cash income and expenditure as in P&L (though P&L additionally takes into account expenses incurred but not yet payable).
As can be seen in the example below, the Cash Flow Statement is generally divided into 3 parts; operating activities (clients paying receivables), investing activities (changes in assets & liabilities) and financing activities (debt & equity/loans).
In conclusion, each of the financial statements described above has its own individual purpose. The P&L shows how assets & liabilities were used, the Balance Sheet is a snapshot of the company at a specific time and the Cash Flow shows the use of money over time, but only when looked at all together do they provide a full picture of the financial state of the company.
If you would like to learn more about financial statements or need help preparing them, please contact us for more information.