In Part I of this article, we discussed the Accounting Equation: Assets = Liabilities + Owners’ Equity. Now let’s look at the main financial statements that you as a business owner are likely to use.
Statement of Comprehensive Income: or Income Statement, is used to determine whether the business has made a profit or loss over a particular period. To determine this, the Statement of Comprehensive Income includes all of the revenue that your business has earned during the reporting period, minus all of the expenses that your business has incurred over the same period.
Statement of Changes in Equity: details any changes in the amount of money that the owners have a claim to. These changes come in the form of any investments or withdrawals that the owners have made, as well as the profit or loss the business made over the period, as recorded in the Statement of Comprehensive Income. The final figure from the Statement of Changes in Equity is then added to the Statement of Financial Position as the owners’ equity.
Statement of Financial Position: unlike the other three statements, which all cover a period of time, the Statement of Financial Position, or Balance Sheet, records the position of the company at a particular point in time. As such, it shows the details of the accounting equation, with assets normally recorded on the left hand side of the sheet, and liabilities and owners’ equity recorded on the right. The totals at the bottom on each side should equal one another if the recording is accurate.
Statement of Cash Flows: as the name suggests, reports the payments flowing into and out of the business. The Statement of Cash Flows is important because most businesses in Australia us an accrual based accounting system, which means income is reported when it is earned, which is not necessarily when it is received. Image that you make a large sale of $20,000 during a particular month, and that your customer arranges to make the payment 30 days later. In your Income Statement and Balance Sheet (and indirectly on your Statement of Changes in Equity as it uses the figure from the Income Statement), you will record $20,000 worth of revenue via accounts receivable. You wouldn’t record this income as cash flow, because you haven’t received it yet. This is an important aspect of business ownership, because what happens if you have a $15,000 bill to pay that month? If you are relying on the $20,000 to cover the payment, you won’t be able to make the payment in time, and only the Statement of Cash Flows will highlight that fact.
Each of these reports has valuable information that will allow you to better understand the financial health of your business, so it is definitely in your best interests to gain an understanding of them.
By Jennifer Lowe