Financial statements are a crucial part of any business’s success story. They provide valuable insights into the company’s financial health, performance, and overall progress. But how do you read them? It can be intimidating to try to decipher complex financial reports if you’re not an expert in finance. That’s why we’ve created this comprehensive guide on how to read financial statements – so that you can confidently understand what they mean and use them to make informed decisions for your business! Whether you’re a small business owner or an aspiring investor, this guide is for you!

What Are the Types of Financial Statements?

There are four main types of financial statements that every business owner and investor should be familiar with. Each statement serves a specific purpose and provides important information about the company’s financial position.

Balance Sheet

The balance sheet is an essential component of financial statements. It presents a snapshot of a company’s financial position at a particular moment in time. The statement highlights the assets, liabilities, and equity held by the company. Reading a balance sheet gives insight into how well a company manages its resources and finances overall. Investors use it to determine whether they should invest in a company, while lenders use it for credit assessment purposes. Analyzing trends on the balance sheet can provide valuable information about liquidity, solvency, and profitability ratios related to investment decisions.

Cash Flow

Cash flow is a crucial financial statement that reflects the inflow and outflow of cash in a business. It is an important indicator of a company’s liquidity and its ability to meet short-term obligations. A positive cash flow means that the company has enough cash to pay off its debts, while a negative cash flow indicates that it may have trouble meeting its financial obligations. The cash flow statement consists of three components: operating activities, investing activities, and financing activities. Analyzing each component can help you understand how your business generates and uses its funds over time. For instance, if your operating activity section depicts increased sales revenue but decreased operational costs, then your business is likely generating more profits from core operations than before.

Income Statement (Profit and Loss Statement)

The income statement, also known as the profit and loss (P&L) statement, measures a company’s financial performance over a specific period. It provides insights into how much revenue the business generated, its expenses incurred during that time frame, and whether it made or lost money. To read an income statement effectively, you need to understand its key components: revenue/sales, cost of goods sold (COGS), gross profit margin, operating expenses/overheads such as rent and salaries of staff, etc., net income/losses after tax. Revenue refers to the amount earned from selling products or services, while COGS is the direct cost associated with producing those goods or services.

Changes in Equity

A Statement of Changes in Equity (SOCE) is a financial statement that provides information about the changes in a company’s equity during a specific period. This statement shows how much of the company’s profits were retained, reinvested, or distributed to shareholders as dividends.

The SOCE includes three main sections: opening balance, movements during the period, and closing balance. The opening balance represents the previous year’s ending equity, while movements during the period include net income/loss, dividend payments, share issuances/re-purchases, and other adjustments. The closing balance reflects the final amount of equity at the end of that particular accounting period.

What’s the Importance of Financial Statements?

Financial statements are crucial for any business, regardless of its size or industry. The primary function of financial statements is to provide an overview of a company’s financial performance and position over a specific period. They help stakeholders make informed decisions about investing in the company or working with it.

One important aspect of financial statements is that they enable businesses to track their progress over time. By comparing current financial information with previous records, companies can identify trends and areas that need improvement. This analysis helps them adjust their strategies accordingly.

How Do I Read A Balance Sheet?

To read a balance sheet, start by analyzing its basic structure. The left-hand side lists all the assets owned by the business, while on the right-hand side are listed all their liabilities and equity. Assets can be either current or non-current which means they will be converted into cash within 12 months or longer than that.

Next, look for any trends from year to year or quarter-to-quarter. This can help you identify whether there have been any significant changes in asset allocation, such as an increase/decrease in short-term investments, which could indicate an improved liquidity position. It is also helpful to calculate ratios such as debt-to-equity ratio (liabilities divided by shareholders’ equity). 

Keep your analysis grounded with knowledge about where these assets came from – loans versus revenue-generated – so you can better assess how sustainable their growth might be over time!

How Do I Read A Cash Flow Statement?

To read a cash flow statement, start by looking at the top section, which shows the net increase or decrease in cash during the period. Then move on to operating activities, which include transactions related to producing and delivering your product or service. This will show how much money was brought in from sales and how much was spent on expenses like salaries and rent.

How Do I Read An Income Statement?

Reading an income statement might seem daunting at first, but with a little practice, it can become much easier. Start by understanding the basic components of the statement – revenue, expenses, and net income. From there, you can move on to analyzing trends in each category over time.

The first section of an income statement typically outlines the total revenue earned by the company during the specified period. This includes all sales and other forms of income generated by the business. Next, we see any direct costs associated with generating this revenue, such as cost of goods sold (COGS). Subtracting COGS from total revenue gives us gross profit.

After gross profit, we see operating expenses which include things like salaries, rent, marketing expenses etc. These are necessary expenses for running the business but don’t directly contribute to generating revenue. Subtracting these operating expenses from gross profit gives us operating profit. We have non-operating items like interest expense and taxes that bring us to net profit after tax. This final number tells us whether or not the company made a profit overall during this period.

How Do I Read a Statement of Changes in Equity?

Reading a statement of changes in equity may seem daunting, but it’s actually quite straightforward. First, you need to understand that the statement shows how a company’s equity has changed over a specific period of time. It includes information about any dividends paid to shareholders, any share repurchases made by the company and any profits or losses incurred.

The key thing to look for when reading this statement is whether the overall change in equity is positive or negative. If it is positive, then it means that the company has generated more capital than it has used during the period specified in the statement. On the other hand, if there is a negative change in equity, then this suggests that the company has spent more money than it has generated.

It’s also essential to pay attention to specific items listed on this statement such as stock-based compensation or foreign currency translation adjustments as these can significantly impact changes in equity.

Tips For Comparing Financial Statements

Here are some tips for comparing financial statements:

First, make sure you’re comparing apples to apples. In other words, compare financial statements from the same time period and using the same accounting methods.

Next, pay attention to trends over time. Look for changes in revenue, expenses, and profits over several periods. This will give you a better understanding of whether your business is growing or declining.

Another tip is to look at ratios instead of just raw numbers. Ratios allow you to compare different aspects of your business like profitability or liquidity, against each other and against industry standards.

By following these tips for comparing financial statements and being diligent about monitoring your company’s finances on an ongoing basis, you’ll be well-equipped to make informed decisions about the future direction of your business.

How Do I Use Financial Statements To Make Business Decisions?

Once you have a basic understanding of financial statements, you can use them to make informed business decisions. Here are some ways to utilize financial statements:

Firstly, analyze trends in the data over time. This will help identify areas where your company is improving and those that need more attention.

Secondly, compare your financial statements with those of other companies within the same industry. This will give you an idea of how well your company is performing compared to its competitors.

Finally, use ratios such as liquidity and profitability ratios to evaluate the health of your business. These ratios can provide insights into how efficiently your business is operating and whether it’s generating enough revenue.

What Is EcomBalance?

EcomBalance is a monthly bookkeeping service specialized for eCommerce companies selling on Amazon, Shopify, Ebay, Etsy, WooCommerce, & other eCommerce channels.

We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.

You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.

Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.

And here’s some free resources:

•     Monthly Finance Meeting Agenda
•     9 Steps to Master Your Ecommerce Bookkeeping Checklist
•     The Ultimate Guide on Finding an Ecommerce Virtual Bookkeeping Service
•     What Is a Profit and Loss Statement?
•     How to Read & Interpret a Cash Flow Statement
•     How to Read a Balance Sheet & Truly Understand It

Conclusion

Financial statements are crucial tools for anyone looking to understand the financial health of a business. They provide valuable insights into a company’s performance and can be used to make informed decisions about investments, acquisitions, and other financial matters. While interpreting financial statements requires some knowledge and skill, it is something that anyone can learn with practice. By following the tips outlined in this guide and seeking out additional resources as needed – you’ll be well on your way to mastering the art of reading financial statements like a pro!