Understanding Financial Statements: A Definitive Guide for SMEs | CloudCfo
Understanding Financial Statements: A Definitive Guide for SMEs

Understanding Financial Statements: A Definitive Guide for SMEs

Posted on August 31, 2022
8 mins read

Numerous transactions and documents come with running a business, which can sometimes get overwhelming. However, recording and keeping them organized are crucial, especially during the audit season and when it is time to expand your business. Financial statements are documents that play a major role in these events.

As a business owner, you should fully review and understand financial statements to run your operations smoothly. These culminate in your accounting team’s bookkeeping works, providing insightful data to help you make big financial decisions for your enterprise. But what are financial statements, and how can they help your business? 

This hefty guide can help you understand financial statements as part of the small and medium enterprises (SME) scale.

What is a Financial Statement?

Financial statements summarize the status of your business finances. It provides investors with an overview of your company’s activities and financial performance to ensure that they invest in a company that will yield a great return on investment (ROI). For easier comparison, this often includes two periods: the previous and recent fiscal years.

Statutory financial statements should be at the top of your list during audit season. Government agencies use these to ensure transparency and compliance with the law. Meanwhile, internal financial statements guide your management team in making data-driven decisions on certain company matters to operate at optimal levels.

Data must be accurate and timely since these are consolidated from one statement to another, allowing you to gain deeper insights into your company’s financial health. But what are the types of financial statements and their inclusions?

What is Included in a Financial Statement?

The significance of financial statements prompts businesses to keep them in order, but it can be difficult if you’re unaware of what needs to be accomplished in the first place. Below are some types of financial statements and the information each document should have to help your audit preparations.

  1. Balance sheet

This financial statement provides a snapshot of where your company stands at a point in time, outlining your assets, liabilities, and equity. Balance sheets enable key personnel in the business plan since they supply an overview of everything your company owns (or owes). 

The balance sheet is divided into two sides that must result in equal values: the assets side and the liabilities plus the equities side. As such, its formula is as follows: 

Total Assets = Total Liabilities + Total Equities

  • Assets

Your assets show what the business owns. Your company can hold a wide range of assets, often

arranged by liquidity, where the most liquid items take the top spots. These include cash,

accounts receivables, inventory, equipment, prepaid expense, real estate, long-term and short-term investments, and trademarks.

  • Liabilities 

If assets are what your company owns, liabilities are what your company owes. The liabilities portion of your balance sheet is arranged in order of maturity, where short-term liabilities come first before long-term ones.

Your current liabilities include accounts payable and short-term debt like ones from your business credit card, while noncurrent liabilities often refer to long-term debts like mortgages. Others may be accrued expenses, namely utilities, rent, and wage payables.

  • Equity

Also known as shareholders’ equity, it is the value left after liquidating all assets and subtracting the liabilities. This part of the balance sheet often includes the capital given by your investors. You can also return retained earnings to the business, becoming a part of your equity. 

  1. Income statement 

Your income statement shows you the value your company makes within a range of time. It is typically the first thing your investors or analysts will consider, allowing them to see your company’s overall profitability.

The sales revenue is usually placed on top, followed by the expenses. With that, its formula is: 

Net Income = Revenue – Expenses

You can further break this down to this: 

Gross Profit = Revenue – Cost of Goods Sold (COGS)

Net Profit = Gross Profit – Operating, Taxes, and Interest Expenses

  • Revenue

Operation revenue is what you earn from rendering services or selling products. In other words, you can obtain this from your company’s core business activities.

Meanwhile, non-operating revenue is what you generate from non-core business activities, including rental income, interests earned on cash in the bank, income from ad displays, and strategic partnerships. In either case, this already includes credit and cash sales.

  • Expenses

Expenses are often arranged, from operating expenses to tax and interest expenses. Their most common examples are salary, utilities, depreciation, transportation, training, electricity, research and development, and COGS. You incur these costs as your business operates throughout an accounting period.

  1. Cash flow statement

The cash flow statement shows how the money moves in and out of business. It tells you how well your company can generate cash while settling your obligations and funding investments. 

Your cash flow statement can help your management team control your resources and ensure that your finances are optimal. It only considers pure cash movement, doing away with credit items—ensuring that your company stays liquid for unexpected expenses.

  • Operating activities 

Any sources and expenditures of money resulting from operating the business and making sales are included in this particular category. Any cash movements related to business operations are jotted down here, including receivables collected, paid accounts payable, cash sales of inventory, and cash payments for utilities.

  • Investing activities

Cash movements related to the company’s longevity are all under this classification. Investments, such as selling and buying stocks or bonds, equipment, properties, and real estate, are a few examples.

  • Financing activities

If you receive financing from investors and banks, you can write them down in the financing activities portion of your cash flow statement. It includes loan payments to banks and dividends to your shareholders—common outflow cash movements.

  1. Statement of changes in equity 

This financial statement keeps track of equity movements over time, including the shareholder contribution, total share capital, retained earnings, dividend payments, and other accumulated reserves. However, this is often used for public consumption as it does not have much use for the management team. The results from here must reflect in the income statement and balance sheet.

  1. Notes to financial statements

Your other financial statements may not be enough for the management team to develop a strategic plan due to the lack of context. 

Notes to financial statements are an International Financial Reporting Standards (IFRS) requirement to provide a better picture of your company’s financial situation. It discloses all information about your financial statements for concerned parties to understand it more deeply. 

For example, notes to financial statements show a breakdown of all items in your assets. They also state the assumptions, accounting policies, and estimates—all of which contribute to deeper insights into those accounts. That way, authorities, and other stakeholders can ensure you stay compliant with regulations.

Preparing Financial Statements Best Practices

Staying on top of your financial statements does not just end with knowing what documents to complete. It would be best if you also had an efficient workflow for an organized and swift filing process, whether it’s onsite or online filing. Here are some best practices for preparing financial statements for your SME.

  • Ensure books are maintained on an ongoing basis

Financial statements are often the result of your accounting or bookkeeping work at the end of a financial period. It cuts time from sifting through numerous documents when it is time to close books. As such, you must regularly update your books or record all your transactions as soon as they happen.

  • Agree on a standard format for your financial statements

Different statement formatting can be confusing and may lead to costly errors in the long run. It may increase the risk of mistaking the values of one category for another.

A standard and clear format can help your management team easily understand the report and maintain accuracy in your finance function. For example, some companies provide templates to help their team prepare financial statements in a timely and streamlined manner.

  • Utilize the right technology 

The age of technology has brought numerous inventions that make people’s lives easier, including ones for financial reporting processes. It can be a tool powered by complete automation or software that promotes better workflow. Try to look for the best systems to simplify your procedures without compromising invaluable insights.

  • Keep the deadline in mind 

Preparing your financial statements can be difficult when you have limited time and heaps of data to process. So, make sure you dedicate an appropriate amount of time to accommodate deadlines within your company and by the authorities.

Statutory deadlines, like the audit process, happen on the same day each year. However, internal deadlines depend on the company, so make sure you plan your schedule accordingly and give your team enough time to do the work and check for any errors.

  • Work with the experts

Startups and SMEs may not have enough resources to prepare tedious financial statements. Enlisting the help of financial reporting services from experts like CloudCfo can help lighten the load. This way, you can easily meet deadlines while maintaining data accuracy.

Keep Your Company Financially Healthy

Dealing with numerous documents is inevitable when running a business. However, keeping an organized record of everything can help your enterprise during audit season or operations expansion. Your financial statements are a must in this area. 

Proper management of financial statements is important, as these documents do not just give you insights for better decision-making. Having enough knowledge on the matter can make the preparations easier, which helps avoid costly mistakes that can get flagged by government agencies and prospective investors.

Outsourcing to professionals may be just what you need! Finding the right people to accomplish this task can make the process more seamless with great precision. If you are looking for a company to partner with, CloudCfo is a cloud accounting firm that helps startups and SMEs in the Philippines with their financial statement preparation and more! 

Are you interested to know more about our tailored services and processes? Contact us today!

DISCLAIMER: This article is strictly for general information purposes only. Nothing in this article constitutes or intends to constitute financial, accounting, regulatory or legal advice and must not be used as a substitute for professional advice. It is still necessary to consult your relevant professional adviser regarding any specific matter referenced above.

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If you want to know more about our tailored services and processes, drop us a line to discuss how we can help you to grow your business. We will respond to you within 24 hours.

Get In Touch

If you want to know more about our tailored services and processes, drop us a line to discuss how we can help you to grow your business. We will respond to you within 24 hours.