Financial statements are an essential part of financial analysis used by business owners to evaluate their financial performance. They allow for the evaluation of financial stability and forecasting future financial needs.
What are financial statements?
Financial statements are financial reports which provide an overview of a business’ financial position. They provide business owners insight into their company’s financial performance. In turn, this insight enables them to make more informed decisions regarding the allocation of business funds. Business owners can also use financial statements to assess their financial standing with various institutions and potential investors. This information is vital for securing funding or other resources.
In short, financial statements provide a comprehensive overview of a business’ financial activities—which is why they are the first step to ensure ongoing financial success for any business owner. So, what can a financial statement consist of?
Financial statements are made up of balance sheets, income statements, cash flow statements, and other financial reports that provide a detailed breakdown of where money is coming from and what money is being spent on, like the shareholder’s equity statement.
A balance sheet is a financial document that lists the assets, liabilities and equity of a company at a set time. It provides an overview of what the business owns, its current debt position, and how much capital has been invested in or generated by the company. Balance sheets are often made available to potential investors and creditors as they provide valuable insight into the long-term solvency of the business.
An income statement, also referred to as a profit and loss statement, is a vital financial report that records and summarizes an organization’s income and expenses over a set period of time. This statement reveals a company’s income sources, income after expenses, and overall net income. The income statement serves as an important tool for investors, managers, and other stakeholders, helping them to better understand the profitability or lack thereof among their various revenue streams.
Cash flow statement
A cash flow statement is a financial document that summarizes cash inflows and outflows from various sources. This statement allows businesses to track cash transactions by classifying cash flows such as operating activities, investing activities, and financing activities over a given period of time. A cash flow statement can help business owners analyze their cash position, identify potential cash shortages or income surpluses, and understand their overall financial health.
Shareholder's equity statement
A shareholder’s equity statement is an important financial document that reports the total net worth of a company’s shareholders at a specific point in time. It is constructed from the company’s balance sheet and will typically show details on the value of shareholder contributions, retained earnings, additional paid-in capital, treasury stock, and foreign currency translations. By viewing this document, potential investors are able to gain an insight into how healthy a business is as well as understanding where their money might be expected to go should they choose to invest.
Common financial statement mistakes
Startups often face unique financial challenges due to limited resources and inexperienced accounting teams. Thus, startups often underestimate the importance of financial statements when launching their venture. Many fail to pay enough attention to their financial statements, often instead focusing on the development of their product or service.
Common income statement mistakes
Many small businesses fail to properly account for startup costs. These startup costs – such as legal fees, accounting services, and other set up costs – can significantly impact a startup’s profit or loss. However, these costs are easy to overlook if the startup doesn’t have a clear strategy for accounting them in the monthly income statement.
Another common mistake startup businesses make when writing income statements is improperly recognizing revenue. Many startup business owners assume that any sales made are immediately taxable, however this is not always the case and could lead to a discrepancy between the actual versus reported income.
Additionally, startups should be careful to take into consideration cash flow when producing their income statement. Keeping track of accounts receivable and other assets is important to ensure that the startup’s profits are accurately portrayed on the statement.
Common balance sheet mistakes
Startups are often guilty of making mistakes on their balance sheets, often out of inexperience or haste. When setting up a balance sheet, startup owners must pay attention to all the details and make sure entries reflect the true value of assets and liabilities.
A common mistake that startup businesses make is incorrectly recognizing expenses related to long-term projects or growth initiatives on the balance sheet as immediate costs. This can lead to a miscalculation of revenue and unrealistic financial projections, leading to significant losses in the long run.
Poor accuracy and inconsistency between the income statement and the balance sheet may also lead startup entrepreneurs astray when forecasting their cash flow statement.
Common cash flow statement mistakes
One of the most common errors is not understanding the difference between profit and cash flow which can lead to overspending or other financial missteps. Another common mistake is failing to correctly track payments and record them properly in the statement, leading to imbalances between what is being reported and the reality of payments received.
Another misstep is failing to include specific enough line items on their statement. For example, startup owners might simply list marketing expenses as one generic figure in the statement instead of breaking it down by things like advertising, public relations, and media buys – which can give a more accurate picture of startup spending.
Startups sometimes use assumptions in their cash flow statement that don’t always hold up under closer scrutiny. For instance, they may overestimate sales and underestimate expenses, leaving them without enough money to cover operating costs during certain periods. To avoid these oversights, it’s important for startup owners to fully understand their own business operations and be able to track each individual financial transaction.
Common shareholder's equity statement mistakes
Accurately assessing shareholder’s equity is a complex balance of investments, transactions, market trends, and other cost centers. Startup founders must remain vigilant to ensure that these calculations accurately reflect their business model.
Two primary mistakes companies commonly make with their shareholder’s equity statements include failing to accurately define their equity financing, whether through traditional venture capital funding or bootstrapping, and forgetting the importance of monitoring internal transactions related to stock-based compensation or repurchase programs.
Further errors include failing to properly account for the increase or decrease in retained earnings and not clearly displaying transfers of capital between corporate shareholders. Oftentimes startup founders are unaccustomed to structuring equity statements that effectively reflect the current value of their business, leading to inefficiencies that can cause problems such as inaccurate statutory filings and accounting discrepancies down the line.
Avoiding common mistakes
Startups don’t have the luxury of making mistakes on their financial statements. Inaccuracies can cost them time and money. To avoid issues, startups should focus on staying organized by using structured spreadsheets that are regularly updated. Startup owners should also ensure that all documents sent out represent accurate information and always double-check facts. They should also pay close attention to cash flow management and make sure to set aside funds for unexpected issues like supplier payment delays.
Having a good understanding of basic accounting principles is also helpful. Startups should stay up to date with the latest disclosure requirements from regulatory authorities, as they could impact their financial numbers significantly. Adhering to the Generally Accepted Accounting Principles (GAAP) standards is also essential for keeping startup finances in order and up to date with information.
Additionally, startup owners should keep track of major investments and always properly document changes in capital structure to avert any discrepancies. When preparing financial statements, it is critical for startup owners to seek out professional advice from an experienced accountant who understands startup systems and processes in order to ensure accurate presentations of financial affairs. Understanding requirements for financial reporting is essential in any industry, but arguably more so for startups.
Financial statements are a vital part of collecting and tracking financial information for a startup, but unfortunately, startups often overlook financial statements due to lack of financial experience or resources. As a result, it is common for startups to make costly mistakes that could have been avoided with proper financial planning.
With the right strategy and attention to detail, startups can ensure that their financial statements paint an accurate image of their financial standing.