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As we reach the end of another calendar year, thoughts inevitably turn to the budgeting and planning process for the new year. Many, if not most, small businesses manage their financials on a cash basis. Whatever's left in the bank account at the end of the month is considered profit. This may work all the time. There's some cash left over, but that's not always the case in business. Whether it works or not, it's not the optimal way to run a business.
All businesses should operate against a budget. What's the plan, both for income and expenses? What's left over is using income but don't forget taxes and interest expenses. These have to be accounted for before arriving at net income.
By developing a plan and comparing the procedure to actual performance each month, business owners are empowered with knowledge that enables better decision-making for the business in the future. Owners can't spend what's left at the end of the month if they have to invest in inventory for the next month or hold back for quarterly tax payments. With a budget, owners can account for and foresee upcoming expenses and compare their performance against the plan for previous accounting periods.
This financial statement measures a company's financial performance over a specific period and summarizes how a business generates its revenues and incurs its expenses. Also known as a "profit and loss" statement, it's perhaps the most accessible financial statement for non-finance disciplines to read and understand.
This statement is also best used for comparing actual performance eo planned (or budgeted) performance each month. Typically a budget format should be the same as the income statement format facilitating simple comparison on demand.
This financial statement summarizes a company's assets, liabilities, and shareholders' equity at a specific time. The report shows what the company owns and owes and the amount invested by the shareholders and must follow the following formula: Assets = Liabilities + Shareholders' Equity.
It's called a balance sheet because the two sides balance out. Accounts such as cash, inventory, and property are on the asset side of the balance sheet, while on the liability side, there are accounts such as accounts payable and debt.
Statement of Cash Flows
Typically the most neglected financial statements, but arguably the most important as positive cash flows, are essential to solvency. They can represent past activities, such as the sale of a product, or a forecast of future activities, such as investment in inventory or a reduction in accounts receivables, as well as future sales.
Cash flow is crucial to an entity's survival, as having cash on hand ensures that creditors, employees, and others can be paid on time. If a business doesn't have enough money to support its operations, then it's said to be insolvent. Companies with ample cash flow can invest the cash back into the business to generate more money and profit in the future.