Understanding Accounting and Financial Statements

You need to understand the financial situation of your business if you are to know what is happening and why it is happening, predict what is going to happen, and make good decisions for the future. The information below will help you design and interpret your own financial statements. There are also ready-made forms available from a number of sources. If you have questions, refer to the sample business plans for excellent examples of financial statements.

Balance Sheets

A balance sheet shows the worth of the business. Traditionally, the business’s assets are shown on the left side of the page and liabilities and net worth on the right.

                                   Assets = Liabilities + Net Worth

There are two main categories of assets: current assets (anything that can be converted to cash within a year) and fixed assets (buildings, equipment, etc.). Liabilities are divided into current liabilities (short-term bills such as inventory, salaries, etc.) and long-term debt (such as mortgages, etc.).

The difference between the assets and liabilities equals net worth.

Profit and Loss Statements

Follow the money coming in and going out over time in your business with a profit and loss statement. Blank spreadsheets are available from local agencies, such as the small business development center or SCORE. You can also check accounting books at the library or any business stationary store. Your spreadsheet should have a column for each month and keep track of at least the following information:

  • Total Sales
  • Cost of Sales
  • Gross Profit
  • Owner’s Wages/Draw
  • Salaries
  • Payroll Taxes
  • Supplies
  • Advertising
  • Auto/Travel
  • Dues and Subscriptions
  • Postage
  • Legal and Accounting
  • Office Supplies
  • Telephone
  • Utilities
  • Depreciation
  • Interest
  • Insurance
  • Rent
  • Taxes and Licenses
  • Loan Payments
  • Net Profit/Loss

Cash Flow Projections

Cash flow projections tell you where your money is going and if you are likely to have sufficient money each month to operate the business. Buy or create a spreadsheet with a column for each month. (Blank spreadsheets are available from local agencies, such as the Small Business Development Center or SCORE. You can also check accounting books at the library or any business stationary store.) Fill in the following information:

  • CASH IN
    • Cash Sales
    • Paid Receivables
    • Interest
  • CASH OUT
    • Rent
    • Payroll
    • Taxes
    • Inventory
    • Utilities
    • Office Supplies
    • Loan Repayment
    • Miscellaneous
  • ENDING BALANCE (Starting Cash + Cash In – Cash Out)

Ratios

Financial statements help you track and analyze financial information. Ratios are then often used for decision-making. Some common ratios include

  • Liquidity ratios. These measure the amount of cash available to cover expenses.
  • Profitability ratios. These ratios measure profit margin, return on assets, return on investment, and return on sales to help control income.
  • Efficiency ratios. These help you keep track of inventory turnover, return on assets, and credit sales. They measure how well you are conducting your business.

Even when you understand how they work, financial statements and ratios can be complex. You may still want to consult a professional for help in setting up, interpreting, and making decisions from financial statements.