It has been my experience that all watchful business owners have an innate sense of how well their business is doing. Almost without thinking about it, these business owners can tell you any time during the month how close they are to hitting budgeted figures. Certainly, cash in bank plays a part, but it's more than that.
Helpful is the routine review of financial statements. There are three types of financial statements. Each will give you important info about how efficiently and effectively your business is operating.
The first step in learning how to prepare financial statements is understanding the accounting system, which is how you get transactions to show up on the financial statements.
The income statement shows all items of income and expense for your arts or crafts business. It reflects a specific time period. So, an income statement for the quarter ending March 31, shows revenue and expenses for January, February and March; if the income statement is for the calendar year ending December 31, it would contain all your information from January 1 to December 31.
Income statements are also known as statements of profit and loss or P&Ls. The bottom line on an income statement is income less expenses. If your income is more than expense, you have a net profit. Expense more than income? You have a net loss.
Accounting is based upon a double entry system - for every entry into the books there has to be an opposite and equal entry. The net effect of the entries is zero, which results your books being balanced. The proof of this balancing act is shown in the balance sheet when Assets = Liabilities + Equity.
The balance sheet shows the health of a business from day one to the date on the balance sheet. Balance Sheets are always dated on the late day of the reporting period. If you’ve been in business since 1997 and your balance sheet is dated as of December 31 of the current year, the balance sheet will show the results of your operations from 1997 to December 31.
3. Statement of Cash Flows
The statement of cash flows shows the ins and outs of cash during the reporting period. You may be thinking – well who needs that type of report? I’ll just look at the checkbook. Good point, unless you’re reporting things that don’t immediately affect cash such as depreciation, accounts receivable and accounts payable.
If I could only choose one of those three financial statements to evaluate the ability of a company to pay dividends and meet obligations (indicating a healthy business) I would pick the statement of cash flows. The statement of cash flows takes aspects of the income statement and balance sheet and kind of crams them together to show cash sources and uses for the period.