How to prepare a financial statement for a small business.
Financial statements are the outputs of your book keeping and accounting efforts. It can be described as the report card of your business. Financial statements are an important management tool. When correctly prepared and properly interpreted, they contribute to an understanding of financial condition, problems and possibilities of a business. Financial statements are the principal means of reporting financial information about a business to stakeholders. Stakeholders include people within an organization and to people outside the organization such as shareholders, lenders, employees, customers, creditors and the government. It can be prepared monthly, quarterly or annually.
The essence of business financial statements is to help you know the status or the performance of your business at any given point. More than often, the information contained in the business financial statements will guide you on the decision you need to take regarding the business. It is not enough to know how to prepare a financial statement for a small business, you need to have have good understanding of the components of business financial statements and the different information they provide for different users.
Components of Business Financial Statements
The components of small business financial statement include the following:
- Statement of financial position
- Income Statement
- Cash Flow Statement
Statement of Financial Position
Statement of financial position is a quantitative summary of financial condition of a business at a specific point in time. This includes assets, liabilities and net worth of the business. It shows what a business owns and what it owes at a fixed point in time. Essentially, it measures the cumulative result of your business efforts. Statement of financial position is divided into two namely Assets; Liabilities and Networth. Networth can also be referred to as Shareholders’ fund. A business assets have to equal the sum of its liabilities and networth. The simple Accounting equation is:
Assets = Liabilities + Shareholders Funds.
The above equation can be expressed in another form as follows:
Assets – Liabilities = Shareholders Funds.
Assets are things that a business owns that have value. They can either be sold or used by the business to make products or provide services that can be sold. Assets are normally debit balances. They are divided into two groups namely current assets and fixed assets.
Fixed Assets: Fixed assets are called long term assets because they are more permanent in nature. They are not intended for resale. Fixed assets are usually recorded at cost less accumulated depreciation. Examples are: land and building, motor vehicle, plant and machinery. Following the definition of fixed assets that they are not intended for resale, this implies that if you deal in selling motor vehicles, such motor vehicles will not be regarded as fixed assets. In this case, motor vehicles will be treated as inventories. As a result of the permanent nature of fixed assets, it is always advisable that they are financed with long term capital.
Current Assets: Current assets are things a business expects to convert to cash or used within one year. Examples are cash and bank balances, short term investments, receivables and inventories.
These are your obligations to others which arise during the course of your business operations. Liabilities are further classified into long term and short term liabilities.
Long Term Liabilities: They are obligations which are not due for payment within a year. A good example is bank loan.
Current Liabilities: These are obligations due and payable within one year e.g. trade creditors, bank overdraft and wages payable.
Networth or Shareholders’ Funds
Networth is the portion of a business assets that the shareholders own, as opposed to what they’ve borrowed. It is all the money belonging to the company’s shareholders which includes the share capital contributed and all profits retained in the company.
In your quest to know how to prepare a financial statement for a small business, you can ignore income statement. Income statement is a report that shows how much revenue a business earned over a set period. Unlike the statement of financial position, the income statement is a temporary statement. It accumulates information over a (usually monthly or quarterly) at the end of which its numbers are reset to zero in order to start tracking activity of the next period. It also shows the costs and expenses associated with earning that revenue. It tells you whether the business made profit or loss over the period.
Components of Income Statement include the following:
This is the total revenues earned during the accounting period. Sales are usually recorded as net of returns, allowances and discounts. It includes both cash and credit sales. Sales on credit will only create paper profits if the debts are not recovered from the customers. This means that amount which has earlier been reported as profits can reduce or be wiped away by reason of bad debts.
Cost of goods sold
These are all the direct costs related to the product or rendered service sold and recorded during the accounting period. Matching the revenues earned during an accounting period with the cost associated with the period to ascertain the result of the business concern is very crucial. This is the only way by which accurate profit for a period which can be safely distributed to the owners can be ascertained.
These include all other expenses that are not included in Cost of goods sold but are related to the operation of the business during the specified accounting period. This account is most commonly referred to as administrative expenses. This includes expenses such as salaries, selling and marketing, maintenance, administrative and other office expenses including depreciation and amortization, etc.
Other revenues & expenses
These are all non-operating expenses such as interest earned on cash or interest paid on loans.
Income taxes – This account is a provision for income taxes for reporting purposes.
It is important to note that the preparation of business financial statements is guided by Accrual Concept. This requires that income and expenses must be recognised in the accounting periods to which they relate rather than on cash basis. This means that income must be recorded in the accounting period in which it is earned rather the period in which it is actually received. On the other hand, expenses must be recorded in the accounting period in which they are incurred rather than in the period in which it is paid.
Cash Flow Statement
Preparation of a financial statement for a small business is not complete without knowing how to prepare a cash flow statement. Cash flow statement reports a business inflows and outflows of cash. It shows details about the cash that moved through the business during the tracking period—how it came in, and how it left. While an income statement can tell you whether a business made a profit, a cash flow statement can tell you whether the company generated cash.
Cash flow statements are divided into three main parts:
- Operating activities;
- Investing activities; and
- Financing activities.
Operating activities include the production, sales and distribution to the customers of the business product. It also includes collection of payments from its customers. This activity could include purchasing raw materials, inventory and advertising of the product. It analyses the changes in the working capital of a business. Adjustments are usually made for items that do not involve the movement of funds. Such items include depreciation, amortization and interest income.
Investing activities are activities that relate to the purchase of long term assets in order to ensure that the business of the company continues. Investing cash flows are the cash flows arising from the purchase or disposal of non-current assets. Cash can also be generated from the sales of fixed assets or divestment.
Financing activities include resources obtained from lenders and owners of the enterprise, loan repayment as they become due and payment of returns to the providers of resources e.g. Interest and dividends.
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