Understanding your accounts - The anatomy of Financial Statements
AKA #WTF do all these things actually tell me?
Financial statements. Annual Report. The accounts. The books. A P&L. A Balance sheet.
Many names, but what do these things refer to and what do they show me?
A set of financial statements, also known as ‘the accounts’ (or any of those other terms!) is actually a collection of several individual statements, each providing a particular piece of information.
What is it we want information on?
Well think about the questions you might ask about a company, your company! - how much money is it making? And where is it financially? Does it own much stuff? Does it owe much? Overall where is it?
A set of accounts does exactly this - they provide the information to answer these main questions! Specifically they provide information on how the business is performing, and on its financial position.
Measuring performance - the Profit and Loss account
A business’s performance is most easily measured by the amount of profit it is making. Profit or loss is calculated as the difference between income and expenses. If you have more income than expenses then you have profit, more expenses than income and you have a loss.
(Not sure what I mean by income or expenses? Check out my article on the key accounting terms for business owners here)
Measuring position - the Balance Sheet (aka Statement of Financial Position)
The financial position of a business depends on the amount that it owns and the amount that it owes. Things a business owns are the assets, what it owes are liabilities. Anything that is left over in the business once everything it owes to third parties has been paid, will belong to the owner. That remaining interest is called “owner’s capital” or ”equity”.
Measuring solvency - The statement of Cashflows
Solvency is a fancy word, sometimes also termed 'liquidity'. Generally speaking solvent is good and insolvent is bad!
The statement of cashflows does what you may imagine from the name - it is a statement showing the flows of cash! A bit like a bank statement, it shows what is coming in and going out, but rather than being organised by date, it shows the totals in and out for a period (typically the same as the Profit and Loss account) organised by why the cash is, well, flowing. Lol. Cash is very important to businesses, particularly new businesses. You can think of it as the blood of a business - it must flow in order for the business to function. Too much going out and not coming back in is not healthy. This is where good working capital management, and budgeting, is essential.
These three financial statements are the main components of a full set of accounts for a business. They allow you to check:
a) whether you are making profit or not
b) how much you have saved up in the business vs what is owed to others and
c) whether cash is overall coming in or going out, and why, so you can work out if you can pay those bills you have or not!
The next level of information from the financial statements would be to analyse or interpret the statements - and I'll tell you more about that another time!
Is there something specific in a set of accounts you don’t understand the purpose of? Or what it means? Add it below and I'll ensure it's included in future updates.