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Behind the Numbers: How to Read and Understand Financial Statements
Have you ever been asked if you can read financial statements? Perhaps a balance sheet, statement of cash flow, or income statement? Maybe you think you don’t need to read them since you aren’t involved in your company’s finances or maybe you just aren’t sure why they matter. But knowing how to read and understand financial statements will make you more valuable to your company. Even outside of work, it’s a worthwhile life-skill that comes in handy more often than you might think.
If your company’s financial statements aren’t easily accessible, this may be more difficult for you to learn. You might want to question why you can’t access the statements or why it’s so difficult to hunt them down. But, if your company has open books, then you’ll want to use those. Before you delve too deep into the books, let’s go over a few pointers so you actually know what you are looking at.
There are three common financial statements that companies use for various reasons. Below, I provided details on each of them and explained their importance.
The Balance Sheet
Balance sheets provide a snapshot of what a company owns and owes during a specific period of time, as well as investments from shareholders. Balance sheet items generally fall under one of three main categories: assets, liabilities, and equity. The accounting equation for a balance sheet is, assets = liabilities + equity.
- Assets: Resources a company owns, including cash and accounts receivable
- Liabilities: Money owed to outside parties (a.k.a. accounts payable or notes payable)
- Equity: Money paid in by shareholders, money taken out by shareholders, and any retained earnings (which are net earnings that are reinvested in the business or used to pay off company debt)
Balance sheets are important because they provide information about the liquidity of the company and company performance over time. They also help companies get credit.
Statement of Cash Flow
Cash flow statements record any cash that enters and leaves the company account during a specific period of time. Like balance sheets, cash flow statement items also fall under one of three main categories: operating activities, investing activities, and financing activities.
- Operating activities: Sources and uses of cash from business activities (i.e. net income, accounts receivable, accounts payable, sales, wages)
- NOTE: Many operating activities are identified by comparing numbers from the current year to the previous year
- Investing activities: Cash spent on property, plant, and equipment
- Financing activities: Sources of cash from investors or banks and cash paid to shareholders
Cash flow statements are important because they provide a valuable measure of financial strength or stability and company profitability. They also provide a foundation of data you can use to assess or predict the long-term outlook of your company.
Statement of Income
Income statements, also known as profit-and-loss statements, summarize the revenue, costs, and expenses incurred during a specific period of time. Items typically include income/revenue, cost of goods sold, gross profit, expenses, and net income. Here are some definitions for these items:
- Income/revenue: Income collected or is expected to collect from normal business activities
- Cost of goods sold (COGS): Direct costs attributable to the production of goods sold – so basically, anything purchased in order to produce goods or services solid by your company
- Example: In BrainSell’s case, the reselling aspect of our organization requires us to purchase software and technologies from vendors to provide to our clients, so these are considered COGS
- Gross Profit: Income/revenue – COGS = gross profit
- Expenses: Costs associated with operating the business (i.e. payroll, rent and overhead, taxes, office expenses, etc.)
- Net income: Residual amount of earnings after all expenses have been deducted from sales – this is essentially the bottom line of what the company has gained (or lost) during a specific period of time
Income statements are important because they communicate the financial health of your company, as well as any areas of weakness. Your team can leverage this information to gain insight on performance and health, and on which aspects of business operations need improvement.
Each of these financial statements have their own unique importance and application for internal employees, external stakeholders, and your company as a whole. But the only way you can understand what’s behind these numbers is to learn what they mean and how they are calculated. Whether you’re CFO, Director of Marketing or the mail room clerk – if you can read financial statements, you can offer insight or perspective that could really help your company.
This skill could also help you protect yourself from being taken advantage of and make decisions about your career path. (For example, maybe you don’t want to stay with a company that’s hemorrhaging money and being dishonest about it?)
However you chose to use it, this is a valuable skill that’s worth investing in!
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