“Show me the money!”
None of us are likely to forget Cuba Gooding Jr’s delivery in the 1996 cult-classic Jerry McGuire. But his Oscar-winning line doubles its meaning in the accounting industry (you could say it’s a mantra for us CPAs). Every financial statement we prepare does just that: shows you where your money came from, currently is, or went.
But why do we need four different statements to show you the money?
All 4 Financial Statements
Just like your dentist should not diagnose your overall health, you shouldn’t rely on any one statement to determine the state of your business’s finances. The four statements– balance, income, cash flow, and retained earnings– each communicate a unique aspect of your accounts and together provide an in-depth examination of your financial health.
Here is what each financial statement does and why it matters:
Your balance sheet provides a snapshot of your financial health at a given moment. Think of it as the results of your most recent physical. At a particular day and time, your balance sheet shows your company’s assets (what you owned), liabilities (what you owed) and equity (the historical value of your investment and your accumulated earnings).
Because your balance sheet reveals how efficiently you utilize your resources, it provides insight on whether you can acquire more capital, distribute your dividends, and even pay your bills. It also allows for a better, more accurate budget, which every company needs to prepare projects and better communicate large-picture plans.
As your business grows, your balance sheet becomes invaluable by providing the information necessary to determine your solvency vs. liquidity ratios and determine the right balance between debt, assets, and revenues.
Also referred to as profit and loss (P&L) statements, income statements show your revenue, expenses, profits, and losses over a given period. Where one doctor’s visit provides your current blood pressure during that particular day, several visits help your physician conclude how your blood pressure is changing and how you can proactively respond to these changes. Similarly, this statement tracks changes in your balance sheet and reveals your business’s financial trends.
Profit and loss statements identify which aspects of your operations correlate to high-growth periods and which do not. Typically, your business should put money toward processes that generate growth, rather than stagnation.
Analysis of your income statements can also forecast and assess risks to guide where you invest resources. By projecting trends from your income statement, your business can predict how possible initiatives might translate into revenue. These forecasts are crucial when securing stakeholders because they ensure that your business model is stable and your operations are profitable.
Cash flow statements outline how cash comes into your accounts and how it leaves for investing, financing, and operational purposes. Tracking your cash flow reveals where your outflow is sustainable, which is where you should devote more cash for growth.
Like getting a second opinion on a diagnosis, cash flow statements are crucial for avoiding discrepancies between revenue and cash flow. This statement shows only changes in cash balances and corrects for balances sitting in accounts receivable, accounts payable, or other accrued items that might be mismarked in your books.
Your cash flow is also critical for securing investors by proving your business’s viability and stability. This statement provides a period of cash flow for investors to really judge the company’s runway and bleed rate.
Also called statements of shareholders’ equity, your retained earnings statements track changes in your business’s stake over time. On your Cap Table, this is the financial aspect which reports your accumulated profits after you have paid out your stockholder’s dividends.
This statement does not need to be generated as rigorously as your other statements. But it is crucial for fundraising because it demonstrates whether your profits are positive or negative in a given period.
Your statement of equity helps lenders determine whether they should trust your company on credit. Stakeholders want security in their investments and need to know what you are doing with your profits that will generate a high return for them. If your statement shows a consistent upward trend, investors are more likely to work with your business.
These four financial statements are vital for diagnosing your financial health, achieving your objectives, and growing your business. By identifying where your business is profitable, these reports guide management decisions and secure investors. But leveraging these reports can also be incredibly time-consuming. Having a financial expert synthesize your statements provides you with actionable information and more time to ensure success for your business.