Often, a common question I receive from clients who are starting their own business for the first time is whether or not financial statements are needed and what exactly do they do. For an accountant like myself, this is a very obvious answer (yes, you need them!), but I think it’s important to clarify the objectives of financial statements and what purpose they serve. I’ve gone into detail in the past 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 make false assumptions about whether their business is profitable without actually knowing for sure that this is the case. These are just some examples of what purpose they serve.
What are the Financial Statements?
Firstly, it’s important to understand what the three financial statements small businesses use in Australia. These are:
- Profit & Loss Report: displays the profitability of a business over a period of time
- Statement of Financial Position: summarises all business assets and liabilities, at a particular moment in time, to show how much money remains if the business were to sell all assets and paid off all debts. This is otherwise known as ‘owner’s equity’
- Cash Flow Statement: displays how much cash is moving in and out of the business over a certain period of time
Each report serves several different purposes and can be used alone or in combination with one another for different business objectives. These objectives include…
1. Identifying Business Profitability
The profit and loss report helps to identify whether your business is truly profitable. Rather than looking at your bank account and taking a wild stab in the dark, income statements generally include your gross revenue minus your gross expenses (or direct costs) to ultimately identify the net income (or loss) of your business. Basing an assumption off of your bank account balance will almost certainly be wrong due to future outgoing costs and incoming revenue that may not be accounted for. Therefore, it’s important that you’re accounting for all revenue and overheads before making this conclusion.
2. Evaluate Tax Liability
When your business is growing and revenue is increasing, inevitably taxes are also following suit. Business owners I’ve dealt with are often shocked at the amount of 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 exactly what your tax liability is, you can look into methods to reduce the amount of tax paid and on your business activity statements.
3. Improve Debt Management
Small business owners are notoriously poor at managing the money they owe and money owed to the business. This is predominantly due to two factors – a lack of understanding of how to manage this and being time-poor. Keeping accurate account receivable and account payable reporting ensures that these correct figures can give you an accurate idea of whether or not your business can continue to operate. Poor management can cripple a business, oftentimes due to delays in receiving income whilst needing to meet their outgoing payment deadlines. When you have an adequate period of data, businesses can often use this as a reference point to accurately predict future cash flow as well.
4. Identify & Mitigate Errors
Having accurate financial statements are crucial in being able to catch costly mistakes, wrongdoing in a business process or even illegal practices. These are usually found in the discrepancy of financial numbers and therefore, can be caught through the reconciliation of these numbers.
5. Improved Decision Making
If you’re looking to grow and invest back into the business, financial statements such as your statement of financial position, or otherwise known as a balance sheet, can provide a clear visual representation to identify where investment opportunities may lie. Identify such aspects such as the assets the business currently has and whether or it can afford to purchase more is something only a financial statement can tell you. Additionally, using these financial statements for forecasting and planning for the future is important to ensure your business is ready for any changes (or lack of) within the business environment.
6. Proof of Business Success
Financial statements act as historical records for the overall success of a business. In cases where a business owner wishes to sell the business or obtain investment, these financial statements help new stakeholders in deciding whether or not they wish to conduct business. Having a good accountant is important in such cases to ensure records are accurate. If you are in the position as an investor, it is equally important to have an accountant who can performance diligence on financial reports to avoid you making a poor investment choice.
As you can see, there are many reasons why financial statements can benefit your business. By keeping accurate financial statements, it can take the guessing out of business decisions whilst monitoring the progress of your business. When used in combination with suitable accounting software such as Xero or QuickBooks, business owners can benefit greatly in sustaining their business’ success and even expedite their business 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.
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 your own advice for any legal or tax issues raised in your business affairs.