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Understanding financial statements is essential to the success of a small business. They can be used as a road map to steer you in the right direction and help you avoid costly breakdowns. Financial statements have a value that goes far beyond preparing tax returns.
A company’s financial statements provide various financial information that investors and creditors use to evaluate a company’s financial performance. Financial statements are also important to a company’s managers because by publishing financial statements, management can communicate with interested outside parties about its accomplishment running the company. Different financial statements focus on different areas of financial performances.
Business owners who present their financial statements to a lender will usually present a full set of financial statements to the lender. These include a recent balance sheet, a profit and loss statement, a statement of cash flows, and notes to the financial statements. These statements, prepared in accordance with generally accepted accounting principles, usually give a realistic picture of the business activity for the period in question.
The balance sheet will show the assets, liabilities and equity of the company. Make sure you show current assets and current liabilities separately from long-term assets and long-term liabilities. Also make sure the equity section is appropriate for the form of business entity you have, such as sole proprietorship, limited liability company or corporation.
The profit and loss statement could cover a year or part of a year, and could be presented in comparison to the prior year or period. This would be useful if the trend from last year to this year is favorable.
The statement of cash flows can be prepared using either a direct or an indirect method, and there are a variety of acceptable methods to consider in the presentation. The more detail, the better picture the reader of the statements gets. However, you must weigh the additional costs of preparing additional information to the benefits of having that information available to the reader.
The notes to financial statements cover the significant accounting policies employed in preparation of the financial statements, as well as other required disclosures to the statements. The degree of detail presented in the footnotes may lead the reader to seek additional information or enough detail may be presented to negate the need for additional inquiries.
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