Whether you are already running a business or just planning to setup one, it is very important that you have at least a basic knowledge about the fundamentals of Accounting and Recordkeeping.
I don’t mean taking up a formal course in Financial Accounting or Bookkeeping, though it would help. There are a lot of resources available in the Internet and in your local book shops which can get you up to speed in acquiring the basic knowledge of Accounting. What’s best is you can learn this stuff on your own, at your own pace.
Strive to learn up to a point where you understand at least three things:
- Whether your business is making a profit or not.
- Why you are making a profit.
- Which areas of the business are profitable, and which are not.
You don’t have to be an expert with the details, but you should be able to tell the health of your business by looking at the Financial Statements, determine the financial strength of your organization. By understanding the nature of financial statements you can also have an idea as to how well your business is doing with regards to profitability and creditworthiness.
Discussed below are the basic financial statements that any entrepreneur should learn about.
The Balance Sheet
The Balance Sheet gives you a snapshot of the financial condition of the business. It lists the company’s Assets, Liabilities, and Equity. Assets refer to the current resources that keep the company running. Liabilities are the debts of the company. And Equity represents how much your company is worth which can be computed by subtracting the Liabilities from the Assets.
There is a famous accounting equation, which is written as:
Assets – Liabilities = EquityAs you can see from the equation, if Assets are greater than Liabilities the resulting value of the Equity is positive. If that value is negative, the business is in trouble, financially.
Sometimes referred to as the Profit and Loss Statement, this report provides a summary of Income and Expenses of company during a given period (month, quarter or year). This will show the creditworthiness and profitability standing of the business. It demonstrates whether the business earned a profit (earning more than it is spending), or posted a loss.
Cash Flow Statement
In simple terms, a Cash Flow Statement is an accounting of the available cash, plus cash income minus cash disbursements, for a given period. This report helps you track where cash has been used, where and why it is short or in excess. It determines whether the company can meet its obligations or not.
This statement also provides all details pertaining to both inflow and outflow of cash in a specific period. It contains three sections that differ according to the type of activity within the different business transactions: they could be the cash flows from operating activities, investing activities, or with financing activities.
To sum it up: The Balance Sheet gives you value (think: Net Worth) of the business at a specific period in time. The Income Statement gives you the Net Profit of the company. And finally, the Cash Flow Statement provides the details about the incoming and outgoing cash of the company over a period of time.