Understanding your business financial statements may be an added stress when it comes to running a business. Financial statements are your business’s report card, showing how well it is doing and helping you make informed decisions about the future.
Preparing your financial statements forms part of the compliance services that we provide. In this blog, we’ll break down the basic financial statements you need to understand: the balance sheet, profit and loss account, statement of changes in equity, and shareholders’ funds. Don’t worry – we’ll keep it in simple terms, so you can get the hang of it without any jargon!
What is a Balance Sheet?
Think of the balance sheet as a snapshot of your business’s financial position at a specific point in time. It shows what your business owns (assets) and what it owes (liabilities). The balance sheet is divided into two main sections:
- Assets: Everything your business owns that has value. This can be things like cash, property, equipment, or inventory. Generally, assets such as equipment and property that your business owns would be classes as fixed assets whereas assets that are more readily available, are cash or quickly converts to cash, such as inventory or your customers that owe you money.
- Liabilities: What your business owes to others, such as loans, unpaid bills, taxes owed or outstanding debts. If liabilities are due to be paid within less than 1 year, these are deemed current liabilities whereas anything owed in excess of this are long-term liablities.
The balance sheet follows this simple equation:
Assets – Liabilities = Shareholders’ Equity/Funds
This means that your assets are funded either by borrowing (liabilities) or by investment from shareholders (equity).
Shareholders’ Funds: What Are They?
Now, let’s talk about shareholders’ funds, which is the value of your business that is owned by its shareholders (you and anyone else who has invested in the business). It’s the difference between your assets and liabilities. If your business were to be sold and all debts paid off, the remaining amount would be distributed among the shareholders. Shareholders’ funds are important because they represent the financial health of your business. The higher the value of shareholders’ funds, the more equity your business has.
A company must be in a positive Shareholders’ in order to pay out dividends.
The Statement of Changes in Equity
This statement shows how your business’s equity has changed over a specific period, usually a year. It details the movement in your shareholders’ funds, including:
- Profit or loss: The money made or lost by the business during the year.
- Dividends paid: Any profits distributed to shareholders as a reward for their investment.
- Other changes: Such as new investments or adjustments to the value of assets.
The statement of changes in equity helps you understand how decisions, such as paying dividends or making new investments, affect the value of the business and the shareholders’ equity.
The Profit and Loss Account
The profit and loss account (also known as the income statement) is where the magic happens. It shows how much money your business has made (revenue) and how much it has spent (expenses) over a specific period. The result is your net profit or loss – the money your business has earned after expenses are deducted.
Here’s a simple breakdown:
- Revenue: The total income your business has earned from selling goods or services.
- Direct Costs: The costs that directly relate to your business revenue, such as cost of goods or commissions paid.
- Expenses: The costs of running your business, such as rent, wages, and utilities.
- Net profit or loss: The amount left after all expenses are subtracted from revenue. If you’ve made more than you’ve spent, you have a profit; if not, you have a loss.
The profit and loss account gives you a clear picture of how efficiently your business is operating and whether it is financially healthy. It’s a key tool for making decisions about pricing, expansion, and cost-cutting.
Putting It All Together
All of these financial statements work together to give a comprehensive view of your business’s financial health:
- The balance sheet tells you what your business owns and owes.
- The profit and loss account shows you how much money your business is making or losing.
- The statement of changes in equity explains how the value of your business is changing.
- Shareholders’ funds represent the value that is owned by the shareholders, reflecting the business’s net worth.
By regularly reviewing these and understanding your business financial statements, you’ll be able to make smarter business decisions, plan for the future, and show potential investors or lenders that your business is financially sound.
How can Brisan Help?
Understanding your business financial statements might seem overwhelming at first, but once you break them down, it’s just a matter of understanding what each one represents. A good grasp of your balance sheet, profit and loss account, statement of changes in equity, and shareholders’ funds is essential for any business owner.
If you’re new to reading financial statements, don’t be afraid to seek help from us. We can guide you through the numbers and help you interpret the data to make the best decisions for your business.
