Financial statements give you the review of your monitory performance over a period of time. From the financial statements an entrepreneur can understand,
What is the income he generated over a period of time,
What were the related costs to generate that Income
What were his liabilities
What were the assets
What were the cash inflows and outflows
There are typically 3 financial statements which are critical. profit and loss account balance sheet and cash flow statement.
- Profit and loss account: Profit and loss account gives you an understanding of the income generated over a period of time.From a P/L account, you would basically know some of the key info – like, the revenues, the related Direct costs for earning those revenues, and the resultant gross profit, the overheads spent to run the business, and the net profits or losses of the company.
- Let’s take an example of a departmental store. The typical sales for a departmental store over a period will be through the various SKUs sold. The Direct Costs for these products sold could be– the Costs of procuring these SKUs, the Sales Staff of the store, store rent etc. The difference between these two that is there venues and the direct cost is a gross profit. This is very important component to understand from financial point of view. As an entrepreneur, you would want to know the gross profit of your business and how it is growing over a period of time.
- If your gross profit is very thin, you have a very low margin and a very low possibility to grow your business. Under such circumstances maximizing your sales as much as possible is advisable.
On the other hand if your gross profit is on the higher side, you can actually experiment a lot with your business. You can invest more in your business because with scale you would become profitable much earlier. This would be something that your profit and loss account would indicate.
- Balance sheet: Balance Sheet gives you the snap shot of the assets and liabilities of a company as on a particular date.
It can be looked at from 4 components. It has fixed assets, the shareholder’s funds, the borrowings and the net working capital. Now let’s understand each of them independently. Fixed assets include land, machinery, equipment, buildings and other durable, generally capital-intensive assets. Shareholders’ equity is the money attributable to a business’ owners, meaning its shareholders.
- It is also known as “net worth,” since it is equivalent to the total assets of a company minus its liabilities, that is, the debt it owes to non-shareholders. A company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or through investments from investors (issuing shareholders’ equity). Net working capital is the difference between current assets and current liabilities. Typical components of current assets would be the inventory, debtors or receivable, advances etc. The current liabilities would include creditors, trade payable or any other short-term provisions or tax liabilities. The balance sheets gets its name from the fact that the two sides of the equation above – assets on the one side and liabilities plus shareholders’ equity on the other – must balance out.
- Cash flow statement: Cash flow statement tells you about the cash inflows and outflows over a period. The CFS allows investors to understand how a company’s operations are running, where its money is coming from, and how it is being spent. The cash flow statement is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net income, which, on the income statement and balance sheet, includes cash sales and sales made on credit.
- The cash flow statement is partitioned into three segments, namely: cash flow resulting from operating activities – this basically indicates what has been the cash inflow or outflow from the business operations, i.e. from sales, after paying your overheads and your creditors etc., (i.e. cash profit, + net cash flow to working capital)cash flow resulting from investing activities – these indicate investments in fixed assets / any long term investments ,Cash flow resulting from financing activities – i.e. the money invested in the company either by shareholders, or by borrowing through various channels, and if any dividend or interest payout to the same is there, is included here.