4 Types of Financial Statements Founders Need to Understand
This post was written by Justin McLoughlin. Justin is the founder & President of airCFO, a finance & accounting services startup built for startups. He spent the early years of his career in both large and small companies, in a variety of roles, learning how a solid financial team plays a vital part in a company’s overall growth and ability to scale.
Launching a startup of your own is one of the most exciting and challenging business ventures you can pursue, but often every thrill and joy comes with a corresponding setback, or worse, a tedious bureaucratic or procedural hurdle.
You’d like every moment of your day to be filled with closed deals and big sales, but there’s more to it than that. A lot of running a business, unfortunately, involves the somewhat less exciting work involved in creating budgets, managing spreadsheets, performing data entry, etcetera, and analyzing financial statements probably doesn’t rank highly on your list of anticipated startup activities.
For a lot of founders and entrepreneurs, financial statements are and remain a mystery, since most of them didn’t launch their own business to pore over financial data, but even if you don’t have a finance background and aren’t familiar with startup accounting, it’s worth your time to learn some of the basics of the statements you’re likely to encounter.
Below are the four types of financial statements that are relevant to your startup or small business and explanations of how they can be used to understand the financial health of your business and how they might be used to achieve your goals:
This is a straightforward statement, but an essential one, and very valuable to your startup. It shows your business’ performance over a period of time — monthly, by quarter, yearly, or over a longer period. Income statements usually include a detailed section on revenues (sales of goods and services) from which expenses (operational costs like salaries, utilities, transportation, etc.) are subtracted, to achieve a net income figure at the bottom of the statement.
An income statement is a great way to get a handle on the overall health of your startup, and a good starting point for any examination of you business’s financial health. It’s a good place to get into the nitty-gritty of your business by breaking down expenses to get a handle on your profitability or fine-tune your margins.
It’s also important to keep in mind that this is one of the first things a potential investor or lender wants to see, so having an accurate, detailed income statement is a critical part of any raising or investment round.
A balance sheet, sometimes called a statement of financial position, unlike an income statement or statement of cash flows, isn’t meant to show performance over time, but is a snapshot of your startup or small business at a specific moment. It shows your company’s assets, liabilities, and equity. This is another document that stakeholders like investors, lenders, and shareholders will want to see, so it’s important to keep an accurate one on hand.
The balance sheet is named such because the two sides of the sheet are always equal to each other. Simply put, your assets are equal to your liabilities plus your equity — sometimes these values are broken down further into current (short-term) and noncurrent (long-term) values. This is a good way to get a handle on the value of your company at any given moment.
Statement of Cash Flows
This is a relatively simple financial statement, but a critical part of your financial planning. A statement of cash flows shows your expected input and output of funds over a projected period of time (most commonly over the course of a financial quarter, or for the month). This is not the same as an income statement, it’s meant to show the course of the cash that enters and exits your business. Generally, this statement has three sections: cash flow from operations, cash flow from investing, and cash flow from financing.
As you probably know, cash flow is a major problem for a lot of startups, including slick, well-funded ones, and no one wants to get caught in a cash crunch at a critical time. Keeping a statement of cash flows updated and on hand is a critical part of predicting cash flow issues and allowing your startup to plan for the future.
Statement of Changes in Equity
This is a somewhat more specific financial statement, and is usually not relevant until your company has shareholders, but it’s worth understanding ahead of time, and if you have investors, it’s something your business will want to be prepared to produce.
The statement of changes in equity shows shareholder contribution, movement in equity, and equity balance at the end of the accounting period in question. This might record financial events like shares issued or dividends paid out. Note that since these changes will be reflected on your income statement and balance sheet, so that if they’re correctly prepared, the statement of changes in equity will be correct as well.
Accounting for startups can get a lot more complicated, but if you have a handle on these basic financial statements, you’ll be on strong footing to get started and answer any critical questions about the financial health of your company. If you need further help or have questions, you can contact us here to find out more.