By Terry Corbell
The Biz Coach
Primer for Best Practices in Preparing Financial Statements
A good financial system is vital for your business. Not only will a properly prepared financial statement tell you what’s transpired in your business, it will give you a snapshot regarding your future.
Measurement of cash flow is paramount.
In the two forms of accounting – cash basis vs. accrual basis – the cash-basis system is much simpler.
In essence, the salient focus in the cash-basis system is getting money into your bank account. Then, you worry about paying the bills. When you make a sale, you deposit the funds. The date you receive the funds is recorded as the selling date. It doesn’t matter when you made the sale.
Naturally, you pay your bills when the money is available. FYI, it doesn’t matter when the expense was incurred. In a cash-based system, the expense is recorded when it’s paid.
Also, in cash-basis accounting, very little focus is given to matching the time period when the money is earned or the duration when they are incurred.
In contrast, accrual-basis accounting is more complex. It will match your revenue to the actual period of time in which it’s earned; plus, it matches your expenses to the corresponding period of time in which they’re incurred.
Again, it’s not nearly as simple as a cash-based system because it supplies a lot more data concerning the financials of your company. An accrual system gives you more meaningful information. You’re more able to keep records of the payments from the customers to whom you give credit. And it presents more information on your amounts due to your creditors.
So, to keep your fiscal house in order, there is a common-sense approach for preparing financial statements. By using data from your ledger accounts, entries can be made on a worksheet.
For the worksheet, it’s suggested you prioritize your entries in the following order:
- Income statement
- Statement of retained earnings
- Balance sheet
- Cash flow statement
Here’s an explanation of each:
Income Statement. You should include your expenses, revenue, and your net income. That means, of course, you convey your ledger account balances from your expenses, revenue, and your capital gains or losses.
Statement of Retained Earnings. This report contains information from the start and ending of your retained earnings.
A statement of retained earnings is derived from the following sources:
- Using your previous statement of retained earnings, list your beginning retained earnings.
- From the prior income state, show your net income.
- Indicate the dividends paid from this accounting period.
Balance Sheet. Your balance sheet shows the following: Assets, liabilities and equity of shareholders in the company.
How it’s assembled:
- Show the remaining amounts of your asset accounts. They include cash on hand and your accounts receivables.
- Indicate your liabilities in what’s aptly named your liability accounts. This will include all accounts payable and notes.
- List your capital stock balance.
- Record your retained earnings – this is taken from the statement of retained earnings.
Cash Flow Statement. All the data is vital, and my sense is that the cash flow statement is all-important as it reflects your ability to succeed in business.
It includes the numbers that show why there are fluctuations in your cash on-hand. The cash flow statement will indicate your sources of cash. Further it will indicate how you use cash in all phases of your business – including operations, finances and investments.
Remember the difference between accrual and cash systems. As a cash-basis report, your cash flow statement can’t be drawn from the ledger account balances of an accrual accounting approach.
So, you use one of two methods to create a cash flow statement from accrual-system data.
Your optional methods are:
- Direct – subtract your cash disbursements from your cash receipts in this method.
- Indirect – from your net income, you add or subtract your non-cash entries.
From the Coach’s Corner, here related resource links:
- 8 Simple Strategies to Give You Pricing Power
- Step-by-Step Solutions for a Company Turnaround
- Management Strategies for a Successful Turnaround
- What No One Tells You about Raising Investment Capital
- What Should You Divulge When Asking for Investment Capital?
- Eight Strategies to Consider Before Starting A Tech Business
“The fact is that one of the earliest lessons I learned in business was that balance sheets and income statements are fiction, cash flow is reality.”
Author Terry Corbell has written innumerable online business-enhancement articles, and is a business-performance consultant and profit professional. Click here to see his management services. For a complimentary chat about your business situation or to schedule him as a speaker, consultant or author, please contact Terry.