Accounting 101: How to Keep Financial Records
Financial statements are critical to business success. Not only do they help you to understand your company's health and overall performance, they also allow you to plan ahead and set specific goals for the future. There are three key records that must be kept and they must be prepared and reviewed on a regular basis - these include:

Profit and loss statement

Often referred to as an income statement, a profit and loss statement (P&L) summarises how much revenue your business has made, what the businesses' expenses are and what its net income is over a specific period of time. It also comprises accruals, which is income that is determined upon completion of a P&L.

Although profit and loss statements can be developed weekly, monthly, quarterly or yearly, the most common interval is monthly. An added benefit of the P&L, if structured correctly, is that it reveals your best selling products or services as well as areas of escalated spending.

Balance sheet

A balance sheet, or statement of financial condition, acts as a snapshot of your company's financial health and presents a summary of your firms' assets, liabilities and net worth. In layman's terms, it provides a list of tangible and intangible goods that the company owns or owes (otherwise known as assets and liabilities).

  • Assets refer to the resources your business controls and includes items such as equipment, buildings, furniture, cash and money owed to you.
  • Liabilities denote the debts or obligations that you owe to others, such as taxes, loans, accounts payable and payroll.

Once assets and liabilities are cleared, you are left with your net worth (or shareholders' equity). Essentially this is a calculation of your assets minus your liabilities.

Cash flow statement

Cash flow statements capture and predict the way in which money flows in and out of your business over a given period of time. It often acts as a ledger that shows money coming in and money going out and is useful when planning future expenses. A cash flow statement also determines your company's liquidity at a given point in time.

Cash flow statements are a crucial financial indicator because cash flow is critical to survival. Even though you may be generating a profit (as shown on your P&L) your business may not be generating cash. Conversely, your business may be generating cash but there may not be any profit margins.

For example, your sales figures may indicate growth as new customers come on board, but your new customers may not pay promptly. You may also increase spending on stock or inventory in anticipation of growth. Such examples affect the cash position of your business (which is disclosed in cash flow statements) and may hinder your ability to manage critical business activities such as paying your staff and suppliers.

Financial statements are important because they can help you to uncover problems and identify corrective action. At any given point in time the profit and loss statement, balance sheet and cash flow statement measure different financial aspects of your business, allowing you to make economic and operational decisions based on accurate historical data. After all, there is no stronger indicator of future performance than what has happened previously.   

 

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