Why Are Financial Statements Important?
We hear this regularly when we are meeting with business owners; especially relatively new businesses. Some of you may be thinking, “How can you ask a question like that?” Let ‘s see if I can answer both questions.
Financial statements are important for many reasons, but here are three significant reasons.
- Financial statements tell you the performance and the value (sort of) of your company.
- Financial statements are what others are using to measure your company.
- Financial statements and other tools help you manage your company when you can no longer be hands on with all the details.
There are three primary financial statements.
The income (or profit & loss) statement tells you the performance of your company. It shows the revenues earned and related expenses covering a certain period of time like a fiscal year. This statement is designed to show you if you made a profit.
The balance sheet is designed to show you a picture of your assets and liabilities (debts) at a point in time.
Cash Flow Statement
The cash flow statement reconciles the net profit from the income statement to the amount of cash generated for that same period of time.
How Are They Used
So how do these statements relate to the three points above? The income statement shows the performance of your company over a period of time and the balance sheet shows the value of your company (sort of).
Why sort of? Because current assets and debts (due within one year) are shown at their current or fair market value, but other items like machinery, equipment, furniture, etc. are shown at historical costs, meaning that machine you bought 15 years ago or the building you bought 30 years ago is still shown at the value you paid for it, not the value it would sell for today. This is only further confused by depreciation, an accounting tool that attempts to take into account the decline of value over time. Depreciation is subtracted every year to lower the value of the asset to help reflect a more realistic value.
A Simple Illustration
Let’s see if an illustration helps. Your personal income statement would equal your salary less the rent, utilities, phone, groceries, and other expenses you have. Your personal balance sheet would be filled with assets (like cash, cars, house, computer, TV, etc) and liabilities or debts (like a mortgage, car loan, home equity line, etc.). Your Net Worth would be calculated by subtracting your debts from your assets. Your personal cash flow statement, might reconcile between your salary and your paycheck while showing you what you spent on normal living vs. investments or loans.
It is important to have accurate and timely financial statements to understand and run your business. It becomes even more necessary if you are going to get a loan from a bank or sell your business.
Contact Erik Owen (414.852.0015/erik.owen@OakHillBP.com) if you need help understanding your financial statements or using them to run your business more efficiently.
Erik Owen, CPA is the President of Oak Hill Business Partners and has over 20 years of professional experience in Finance and Accounting, Administration, and General Management. He has helped companies as small as $3 million up to Fortune 100 companies.
Oak Hill Business Partners is a Milwaukee, WI based firm focused on the growth of small and mid-sized firms needing expertise in finance, sales, marketing, operations, or mergers and acquisitions. Oak Hill serves the Upper Midwest with partners based in Milwaukee and Indianapolis. In 2012 and again in 2013, Oak Hill was named to the Milwaukee Business Journal’s List of Top 25 Management Consulting Firms Serving Milwaukee.