man and woman doing business accounting
An accurate financial accounting report streamlines business operations and makes your company more appealing to important third parties. — Getty Images/Ridofranz

Small business owners rely on financial accounting reports to make decisions across the company. Investors assess how much funding to offer, employees budget for projects, and leaders use these reports to apply for loans and business credit cards. Without accurate financial statements, gaining insight into your business’s health, performance, and overall stability is difficult.

Good financial reporting relies on four key financial documents, usually generated by the accounting team. These accounting reports outline and summarize a company’s performance to date. Understanding how to generate and use these four reports is fundamental to the success of your small business.

The four basic financial statements

There are four key financial documents that provide an overview of the performance of your business. These accounting reports are:

  1. An income/profit and loss statement.
  2. A balance sheet.
  3. A shareholder’s equity statement.
  4. A cash flow statement.

These statements indicate the financial health of the business. As the U.S. Securities and Exchange Commission (SEC) describes, “They show you where a company’s money came from, where it went, and where it is now.”

An income statement describes how much money your business made and spent over a period of time. A balance sheet shows what your company owns and owes over a period of time. A shareholder’s equity statement shows changes in the interests of the company’s shareholders. And finally, the cash flow statement shows the flow of money into and out of your company over a period of time.

Let’s dive into each of these reports in more detail.

Income statement

According to Robert Duron, PhD, CPA, CFE, Associate Professor of Accounting at Husson University, an income statement provides information on the results of your operations on an accrual accounting basis for a specific period of time—usually one year. It reveals the revenues earned and expenses incurred (including the cost of goods sold if you’re a retailer) and the net income or loss for the period.

“When people refer to the ‘bottom line’ of a business, they are referring to the income statement. It also has to be prepared before any of the other statements can be prepared,” Duron said.

Balance sheet

A balance sheet gives a high-level financial view of your company at a particular point in time, often on the last day of the fiscal year (December 31).

It lists all of your business’ assets, beginning with the most liquid (cash) and then moving in descending order of liquidity to items like receivables (amounts owed), inventory, prepayments for items like insurance and rent, and non-current assets including land, buildings, and equipment.

Additionally, the balance sheet displays liabilities (claims against assets), which represent amounts owed to others and long-term debt.

[Read more: How to Create a Balance Sheet to Ensure Your Business's Financial Stability]

Shareholders’ equity statement

A shareholders’ (or owners’) equity statement indicates the change in equity (assets minus liabilities) for the year.

“The difference between assets and liabilities is called stockholders’ equity if you are a corporation or owners’ equity if you’re a proprietorship, and it represents the stockholders’ claim against your assets,” Duron said.

In addition to extra investments by stockholders or owners during the year, stockholders’ equity rises based on net income earned.

Consequently, it serves as a link between the balance sheet and income statement. Dividends paid (or owner withdrawals) decrease stockholders' equity, and the balance sheet reports the ending balance of stockholders’ equity.

[Read more: When—and How—to Create a Stockholders' Equity Statement.]

Cash flow statement

A cash flow statement reveals your business’s change in cash and cash equivalents over the current year. It uses the cash basis of accounting and classifies cash flows into three major categories: operating, investing, and financing.

Investors will look for this statement in particular since accrual-based net income does not fully provide this information.

“In addition to these four basic statements, you can and should include a document called notes to the financial statements, which expand upon and provide additional information and details on the amounts reported on the actual statements,” said Duron.

Less is typically more in a financial report, as many people find rows and columns of numbers intimidating or overwhelming.

Robert Duron, PhD, CPA, CFE, Associate Professor of Accounting at Husson University

How to design a financial report

The four aforementioned reports comprise the heart of a financial report—a complete set of your financial records, usually prepared once a year, that can be given to investors, lenders, or other third parties.

When creating an annual financial report, “it’s necessary to ensure that the data that went into creating it is complete and accurate. That’s why they should be audited or reviewed by a licensed independent accountant,” said Marilyn Pendergast, CPA and Managing Director of UHY Advisors.

Creating an official financial report is more detailed than simply compiling these documents.

“Your financial report should also include a narrative about what happened in your business during the year,” said Allec.

A complete financial report should answer questions such as:

  • Why was revenue lower this year than last year?
  • Were there any extraordinary items of revenue or expense included in this year's books that couldn't reasonably be expected in future years?
  • Are there any major asset purchases planned for next year?

Duron’s rule of thumb for an effective financial report is simple.

“Less is typically more in a financial report, as many people find rows and columns of numbers intimidating or overwhelming,” Duron said. “Summarize data in reports, but have the details either on hand or in an appendix for those who may wish to see the details. Use color, shading, bolding, underlining, commas, and dollar signs to greatly enhance readability. Don’t hesitate to employ graphs and charts instead of just the dry numbers.”

Why a financial accounting report is necessary for your business

“Implementing an effective financial accounting and reporting system should not be seen as a necessary evil,” said Logan Allec, CPA and Owner of Money Done Right.

“In fact, it is an extremely important part of your company, as it will help you become a well-informed business owner. Furthermore, a proper set of books and financial statements will make your company more appealing to important third parties such as investors and lenders,” he said.

More importantly, even small businesses are not excused for failing to file necessary financial reports and tax returns with local, state, and federal agencies.

“The penalties can be steep, and there are typically no waivers,” Duron said. Also, “sloppy or no financial records is a recipe for inviting theft or fraud from employees, customers, or vendors, as errors and irregularities are much more likely to go unnoticed until it’s too late.”

This article was originally written by Erik J. Martin.

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