10 basic questions on small business financial statements, answered.

Jan 16 2020 | Contributing writer, Aaron Berson, manager and cloud accounting ecosystem curator, EisnerAmper

Learn how to use accounting statements to help you make business decisions based on the health of your company, not emotion or guesswork.
Please note: The information in this article does not constitute tax advice and should not be relied on as such. You should always obtain independent, professional accounting, tax, financial, and legal advice before engaging in any transaction.

As your business grows, so does the amount of financial data you regularly need to sift through – such as cash flows, income, and expenses. Aaron Berson, manager and cloud accounting ecosystem curator at accounting firm EisnerAmper, explains how these statements can help you make business decisions that are based on the health of your company, not emotion or guesswork. If you’re new to financial statements, Berson explains the basics below.
 
Q. What’s a balance sheet?
A. A balance sheet is a snapshot of your business’s financial well-being. It shows your assets, including cash and receivables – money you are owed, and anything you own with financial value, such as equipment and real estate. The balance sheet also shows liabilities – amounts you owe. You can calculate your equity in the business by subtracting liabilities from assets.
 
Q. What are the most important numbers on my balance sheet?
A. All of the numbers are useful, but cash is king in small businesses. A lot of cash, not surprisingly, can be a sign of profitability. In addition to looking at cash numbers, I’d suggest paying attention to your accrual numbers, specifically, “current” and “noncurrent” items, which should be part of every well-organized balance sheet. Current items, such as credit card payables and accounts receivable, should be reviewed during the upcoming 12 months.
 
Q. Can the balance sheet tell me if my business is doing well?
A. In my view, a great way to determine your business’s health is to look at some key performance indicators (KPIs), usually ratios between numbers. These ratios, which can be calculated with the help of a financial advisor, can help you determine your ability to pay off current debt, how fast or slow your inventory is moving, or how long it’s taking to get paid by your customers.
 
Q. What’s an income statement?
A. An income statement is a summary of expenses and income during a specific period of time, usually a year. The income statements exclude PP&E (property, plant, and equipment) expenses. I’d suggest comparing income statements from different time periods, since this can give you great insights about the history of your business and what’s fueling its success – or holding it back.
 
Q. What are the most important numbers on an income statement?
A. We tell our clients that cost of goods or services sold, gross profit, and net income are most important. Together, these numbers indicate how your business is doing in terms of how much it costs you to create your products or services, and how much you’re spending on overhead (expenses like rent and utilities).
 
Q. Can my income statements tell me if my business is doing well?
A. It depends on how long your business has existed, and what stage you’ve reached in your business life cycle. For example, for a startup, losses may mean that you’re making investments in the future – like putting money into product development. A mature company may experience periodic losses from investments, although you may expect to see income as well. The most useful barometer is to compare statements from period to period so that you can spot trends – like growing expenses for overhead.
 
Q. What’s a cash flow statement?
A. The cash flow statement is a summary of how you spent your cash over a period of time. There are 2 methods for displaying cash flow: direct and indirect. The direct method shows all the outflows and inflows of cash, and doesn’t tie it to income or non-cash items. The indirect method, which is most common with my clients, gives you a more detailed view of cash flow: It starts with net income and shows all your non-cash items first, then shows cash flow. The statement of cash flows is broken into three sections to show where you are spending your money: operations, financing, and investing.
 
Q. What are the most important numbers on my cash flow statement?
A. The most important number is cash flow from operations, or “cash burn,” which is the amount of cash needed to fund your business on a daily basis. Another key number to watch is investments in PP&E (property, plant, and equipment) – they’re indicators of your long-term plans and investments in growth.
 
Q. How do I know if my company is doing well based on cash flow statements?
A. A cash flow statement helps you analyze where cash is coming from and where it’s going. The statement includes 3 sections:
1. Operations, or cash spent as part of normal ongoing business expenses.
2. Investing, which means money put back into the business, such as buying equipment.
3. Financing, which covers loans and interest.
 
Among these sections, the best indicator of financial health is probably investing cash flow, which indicates plans for growth.
 
Financial statements may seem intimidating or confusing, but they’re actually very helpful tools for gaining insight into what’s happening with your business. Understanding them is an essential skill for the successful business owner. The bright light of some hard data can provide you with helpful reality checks.

For more information on starting, running, or growing your business, visit the PayPal Business Resource Center often – you’ll find articles on payment processing, selling internationally, and marketing, among many other topics.
 
Aaron Berson is a manager in
EisnerAmper’s Private Business Services group. He serves a diverse client base from startups to mid-sized companies. His expertise includes financial statement preparation, tax preparation, and accounting system implementation and training as well as app ecosystem curation and education.

 
This article is a general summary of certain U.S. Federal income tax laws and regulations relating to small businesses and is provided for informational purposes only. Neither PayPal nor EisnerAmper LLP represent or warrant that the guidance given in this article is complete, appropriate for any particular business purpose or use, or an accurate description of the laws that may apply to any particular taxpayer.

Was this content helpful?