One of the problems when you start a new business is knowing where to start, especially where your accounts are concerned. You probably have an inkling that you should keep a record of anything you spend, and any money coming into the company, but do you really need to get to grips with things like balance sheets, profit and loss statements, and cash flow statements?
The answer to that is a definite yes! Having a broad understanding of what they are and what information they provide will give you a complete picture of the financial condition of your business. And if you understand that, you are immediately in a much stronger position to run you company more efficiently and effectively.
Understanding your Balance Sheet
The balance sheet gives a snapshot of your company’s financial status at a given moment in time and provides important information on:
- Assets: what your company owns which has a current or future economic value to your business, such as stock or cash
- Liabilities: how much your company owes, such as short-term debts and taxes
- Equity: the amount invested in the business.
Understanding your balance sheet is crucial as it gives you an accurate overview of your company’s financial health. So, while you might be thinking you’ve made a massive profit this month and it’s the perfect time to go and buy that new office equipment, your balance sheet could indicate it’s better to wait as you’ve got several massive payments about to go out.
Balance sheets are particularly useful for tracking your business’s financial performance, identifying ways to boost your finances and pinpoint areas for improvement. They are typically prepared monthly, quarterly or annually, but can be prepared at any time if you want to show your company’s financial position. That’s why, if you want a bank loan or are planning on selling your business, you must show an up-to-date and accurate balance sheet.
Interpreting your Cash Flow Statement
A cash flow statement shows how much cash is flowing in and out of your business over a particular time period. As well as showing if cash is going out faster than it comes in, which will impact on whether you can pay any expenses, it’s useful for spotting trends in your income and expenditure as well as for short-term planning.
While cash flow statements vary from company to company, most will include information on:
- Operating activities: these are cash flow activities essential for your business and will include any money you generate from selling goods or services as well as money you spend on producing that product or service.
- Investment activities: these are things that help grow the business such as buying equipment and property, acquiring other companies, and investing in stocks and bonds. It’s normal for startups to have a negative cash flow from investment activities when they first launch as they will need to purchase a number of assets.
- Financing activities: these included anything the company does to get investor financing, such as bank loans and venture capital investment. It also includes transactions involving debt, equity and dividend payments.
Cash flow statements can be prepared monthly, quarterly or yearly, but we would suggest, if you’re purchasing inventory and paying expenses on a monthly basis, then it would be wise to also report on your cash flow monthly. Long-term this will help you identify any slow or good months you have during the year so you can make any necessary adjustments.
Getting to grips with your Profit and Loss Statement
Also known as an income statement, a profit and loss statement (P&L), is the easiest financial statement to understand as it simply extracts expenses from any income generated. It’s also the most important financial report as it tells you if your business is capable of generating a profit. This information can then help you decide whether you should buy that new office equipment or whether to seriously think about expanding your business.
P&Ls are normally completed on a yearly basis. Comparing P&L statements across a few years will provide meaningful insights into your company’s overall financial health.
If you’re wondering how the P&L is different from the balance sheet: the balance sheet reveals your company’s financial position at a particular moment in time, while the P&L shows your company’s financial performance over a period of time.
Who has to submit these financial statements?
The good news is there is no legal requirement for sole traders to prepare a P&L or balance sheet for tax purposes, although we think they would still be worth doing. For anyone who has a limited company then these financial statements must be part of any accounts submitted to HMRC and Companies House.
If you would like more information on how to set up these financial statements or would like us to take you through them in more detail, we would be more than happy to help. We understand that it can all be a bit overwhelming when you first start out (or are even more established!), so we see our role as taking that stress away so you can focus on running your business.
