As an angel investor and a CPA, I am often surprised by the interesting things I find in a set of financial statements of a new company. I thought this month that I would try to give some pointers to entrepreneurs who may be embarking on financial statements for the first time. This is not intended to take the place of your CPA or financial advisor. In other words, do not try this at home. However, I hope it will be useful to help you read statements that others have produced for you – especially if that “someone” is an “app for that”. Keep in mind, however, that there are exceptions to everything. If you don’t understand it, ask.
Accounting likes threes. There are three (and only three) statements in most sets of financial statements. They are the Balance Sheet, the Income Statement and the Statement of Cash Flows. However, the footnotes are an integral part of the statements. They are not a set of financial statements unless they have the footnotes and there pretty much needs to be a footnote for every number on the statements.
A Balance Sheet is a picture of the company’s financials at a particular point in time. There are three sections of the Balance Sheet. They are Assets, Liabilities and Equity. Here’s the thing about the Balance Sheet. It absolutely must balance – no exceptions. Assets= Liabilities+Equity. The total on the assets column has to equal the total on the Liabilities and Equity column. Assets are what the company owns. Liabilities are what the company owes. Equity is what is left. Equity can be negative. Hopefully, that is not your case.
Next comes the Income Statement (sometimes referred to as the Profit and Loss Statement or P&L). This is a picture of what the company has done – financially speaking – over a period of time. The end of that time period must be the same as the point in time of the Balance Sheet. This statement also has three parts. (Imagine that!) The first section is Revenue (or Sales). From Revenue, you subtract Expenses and the result is Profit. Sometimes it is negative and then it is a Loss. Here’s the thing. The “bottom line” regardless of whether it is a profit or a loss has to match that line in the Equity section of the Balance Sheet.
Finally, the Statement of Cash Flows reconciles the cash that has flowed through the company from the beginning of the time period to the end of the time period. This is the most complicated statement and requires professional expertise to do it properly. The main thing to remember is that the cash balance has to equal the cash balance on the Balance Sheet. ( Cash includes bank accounts.)
The most frequent errors I see are that the Balance Sheet doesn’t ( rounding errors are not allowed), the Income Statement and the Balance Sheet don’t match each other, the footnotes are missing and something does not “foot”. To “foot” in accounting terminology means that the total at the bottom of a column of numbers is actually the sum of those numbers. It is amazing how many times columns of numbers do not sum to the number on the page.
When you present financial statements of your company, you are usually trying to impress the reader with your financial responsibility. Making sure these few things are right will at start you off on the right foot.