A common question we receive from clients who are starting their own businesses for the first time is whether financial statements are needed and what they do. For an accountant, this is a self-evident answer (yes, you need them!), but we think it’s important to clarify the objectives of financial statements and their purpose.

Financial reporting is crucial. It ensures the accuracy and reliability of financial statements by adhering to standards such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS).

We’ve gone into detail about identifying financial issues within your business, such as cash flow or reducing the amount of tax paid; however, none of this is possible without financial statements. 

Additionally, business owners often need to learn for sure that this is the case before making false assumptions about whether their business is profitable. These are just some examples of what purpose they serve.

What are the Financial Statements?

Firstly, it’s essential to understand the three categories of financial statements small businesses use in Australia. These are:

1. Profit & Loss Report: displays the profitability of a business over some time
2. Statement of Financial Position: Also known as balance sheets, balance sheets summarise all business assets and liabilities at a particular moment to show how much money would remain if the business were to sell all assets and pay off all debts. This is otherwise known as ‘owner’s equity.’ Balance sheets provide an overview of the company’s assets, offering crucial insights into its overall financial health.
3. Cash Flow Statement: This statement displays how much cash moves in and out of the business over a certain period. It is an essential financial document that reflects a business’s liquidity by tracking cash movement, helping identify potential cash issues, and supporting decision-making for expansion and financial health management.

Each report serves several different purposes and can be used alone or in combination with one another for various business objectives. These objectives include…

Types of Financial Statements

Each type of financial statement provides unique insights into your company’s financial performance and position.

• Balance Sheet: Also known as a statement of financial position, the balance sheet offers a snapshot of your business’s assets, liabilities, and equity at a specific point in time. It helps you understand what your company owns and owes,clearly showingf your financial position.
• Income Statement: Commonly referred to as a profit and loss statement, the income statement shows your business’s profitability over a specific period. It details the revenue generated and expenses incurred, revealing your net income or loss.
• Cash Flow Statement: The cash flow statement shows thecash movementh in and out of your business over a period. It highlights your company’s liquidity by detailing cash flows from operating, investing, and financing activities.
• Statement of Changes in Equity: This statement tracks changes in the equity portion of your balance sheet over time. It ties back to the balance sheet and provides insights into howshareholders retain or distribute profitss.

Identifying Business Profitability With Income Statement

The profit and loss report helps to determine whether your business is truly profitable. As reflected in its financial statements, the company’s financial performance includes key metrics such as profitability, liquidity, and solvency. 

Rather than looking at your bank account and taking a wild stab in the dark, income statements generally include your gross revenue minus your total expenses (or direct costs) to ultimately identify your business’s net income (or loss).

Basing an assumption off your bank account balance will almost certainly be wrong due to future outgoing costs and incoming revenue that need to be accounted for. Therefore, you must consider all income and overheads before making this conclusion.

Evaluate Tax Liability With Financial Statements

When your business growsand revenue increases, iincome tax payments inevitablyfollow suit. Income tax payments are a significant part of the cash inflows and outflows related to operating activities on the cash flow statement. 

Business owners we’ve dealt with are often shocked at how much tax they need to pay and how little they have left after they’ve paid them.

It’s obvious then that all businesses should be looking to reduce their tax burden; however, how can you do this if you don’t know your financial numbers accurately? Once you know your tax liability, you can look into methods to reduce the amount of tax paid on your business activity statements.

Improve Debt Management Using Financial Statements

Small business owners are notoriously poor at managing the money they owe and the money owed to the business. This is predominantly due to two factors: a lack of understanding of how to manage this and a lack of time.

Accurate account receivable and account payable reporting ensures that the correct figures can give you an accurate idea of whether or not your business can continue to operate.

Understanding operating expenses is crucial as they represent the financial obligations a company must meet to maintain its operations, including rent and other essential costs. These expenses are significant in managing cash flow and profit and loss statements.

Poor management can cripple a business, often due to delays in receiving income while needing to meet their outgoing payment deadlines. When you have an adequate period of data, companies can use this as a reference point to accurately predict future cash flow.

Identify & Mitigate Errors Using Financial Statements

Having accurate financial statements is crucial in catching costly mistakes, wrongdoing in a business process or even illegal practices. Detection of discrepancies when reconciling numbers in financial numbers will be able to address this.

Improved Decision Making With Financial Statements

If you’re looking to grow and invest back into the business, financial statements such as your statement of financial position, or a balance sheet, can provide a clear visual representation to identify where investment opportunities may lie. 

These statements offer a comprehensive snapshot of a company’s financial position by detailing its assets, liabilities, and equity. Only a financial statement can identify aspects such as the assets the business currently has and whether it can afford to purchase more. 

Additionally, using these financial statements to forecast and plan for the future is essential to ensuring that your business is ready for any changes (or lack thereof) in the business environment.

Proof of Business Success Using Financial Statements

Financial statements act as historical records of the overall success of a business. In cases where a business owner wishes to sell the company or obtain investment, these financial statements help new stakeholders decide whether or not they want to conduct business. 

 If you are in a position as an investor, it is equally important to have an accountant who can perform due diligence on financial reports to ensure you make a good investment choice.

Importance to Stakeholders

Financial statements are vital not only for business owners but also for various stakeholders who rely on them to make informed decisions.

• Investors: Investors scrutinise financial statements to assess a company’s financial performance and potential for future growth. They use this information to decide whether to buy, hold, or sell their investments.
• Creditors: Such as banks and suppliers, evaluate financial statements to determine a company’s creditworthiness. They must know if the business can meet its debt obligations before extending credit. Employees benefit from understanding their company’s financial position. This helps them see how their roles contribute to the business’s overall success and stability.
• Management: Management teams use financial statements to make strategic decisions, plan for the future, and manage day-to-day operations. These reports are crucial for setting goals and measuring progress.
• Government: Governments rely on financial statements to set regulatory and taxation policies. They use this data to gauge the economic health of businesses and, by extension, the economy.

Financial statementsgive these stakeholdersh a clear view of a company’s financial health, including its profitability, cash flow, assets, and liabilities. This information is indispensable for making sound business decisions, whether investing, lending, or managing operations.

Key Takeaways

• Keeping accurate financial statements can take the guessing out of business decisions while monitoring the progress of your business. 
• When used in combination with suitable accounting software such as Xero or QuickBooks, business owners can significantly sustain their business’s success and even expedite its growth. 
• Box Advisory Services’ team of accountants can assist with preparing these financial statements and provide ongoing business advice to help you improve your business. Book your free 45-minute initial consultation with us today.

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Disclaimer:

Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to contractors and small businesses. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek professional advice for any legal or tax issues raised in your business affairs.