As a small business owner, it’s essential that you understand the financial health of your organization. If you’re running the company yourself, you may have to do some of the business accounting yourself. If that’s the case, there are three key financial documents you should be aware of: balance sheet, income statement, and cash flow statement.
3 essential financial documents for your business
These three documents provide critical information about your business. By creating them and reviewing them periodically, you can gain insights into how your company is performing — and you can see any major issues that need to be handled.
Here’s what you need to know about each document.
1. Balance sheet
Your business’ balance sheet is a statement of your assets, liabilities, and shareholders’ equity at a specific point in time. It gives you an overview of where you business stands in terms of what it owns and what outstanding debt it has.
Typically, businesses organize a balance sheet by listing its assets on the left, and its debt and shareholders’ equity on the right.
Ideally speaking, your business should be balanced, meaning the total value of assets is equal to or exceeds the combined value of your debt and shareholders’ equity. When you review your balance sheet, you can see how well your company uses its assets to generate revenue rather than debt.
Balance sheets should be completed and reviewed on a regular basis. Some businesses update them monthly, while others update them quarterly. By keeping to a schedule, you can track your company’s progress.
2. Income statement
Your business’ income statement, also known as a profit and loss statement, details your company’s income. It helps you determine whether or not your company is currently earning money, and how much of it.
The income statement is for a specific period of time. Depending on your company’s needs, you can detail your company’s profit and losses for a month, quarter, or year.
It will list:
- Income: Your income is any money deposited into your business checking account from the sale of products or services.
- Expenses: Your expenses are your financial costs, such as rent, utilities, labor, marketing, taxes, and debt payments.
- Net profit or loss: To calculate your net profit or loss, you subtract your expenses from your income. If your income outpaces your expenses, the resulting number is your net profit. If it doesn’t, the number is your total loss.
You can use the income statement to determine the health of your business and see how large your profit margins are at a certain point.
3. Cash flow statement
The cash flow statement gives you information on how cash comes into the business and how it’s spent. There are three key sections:
- Operations: This section shows the cash flow in the core of the business’ operations, such as its production costs and total sales. Your operational cash flow can give you an idea of your ability to expand your business, launch new products, or reduce your debt load.
- Investing: The investing portion lists the company’s investments into assets, such as real estate or equipment, as well as any investments it makes into securities. Positive cash flow can be a good thing, but it can also signal that you’re not investing enough in your future. Negative cash flow can indicate that you’re investing in long-term growth.
- Financing: The financing section is a listing of the company’s debt, such as business loans. Your financing cash flow will tell you how well you’re managing your debt.
How these three documents intersect
While all of these documents are important, you shouldn’t view them on their own. Instead, they should be used together. The documents heavily intersect with one another and affect the data on each one. Your net income from your income statement flows into your balance sheet as retained earnings, and the closing balance on your cash flow statement informs the assets on your balance sheet.
By looking at all three documents, you can analyze the company’s performance from different angles. For example, the balance sheet and cash flow statement show you how much capital your business has relative to its debt, while the income statement shows you what your profit margins are.
How lenders use your financial documents
If you’re applying for credit for your business, such as a small business loan, lenders will request these three documents from you since, when used together, they give a comprehensive view of your business’ financial health.
Lenders will look at the balance sheet first so they can get a view of your assets and liabilities. They will often ask for balance sheets from the past three years, and projected balance sheet for the next two years.
They’ll look at your income statements from the past three years to see your company’s earnings and its earning potential in the future. Finally, they’ll look at your cash flow statement to make sure you have enough cash to cover your expenses and your loan payments if approved for a loan.
Creating your financial documents
If creating these three key financial documents seems overwhelming, keep in mind that you don’t have to do it alone. While you can create them yourself, it may not be the most efficient use of your time.
As your business grows, it’s essential that you maintain good accounting practices. It may be a good idea to hire an accounting professional to help you with your bookkeeping and creating these financial documents for you.
Here’s what to consider before hiring an accountant for your small business.
This article was originally written on October 22, 2019 and updated on February 2, 2021.