Your company’s financial statements provide the best indicator of its current financial health and serve as your most effective tool for making critical business decisions. At a minimum, you need to know if your business makes a profit or loses money, but you also need the ability to calculate your business’s current and future financial needs.
What Your Balance Sheet Tells You
Your balance sheet shows the health of your small business at any given time. It tells what you own (assets), what you owe (liabilities), and what you have left over (net value). The numbers on your balance sheet change with every business transaction, so keep in mind that a financial statement only gives you a snapshot instead of a long-term projection.
- Assets: Current assets are everything your business can get its hands on in order of liquidity, such as cash, inventory, and receivables. Examples of non-current assets include furniture, equipment, and property.
- Liabilities: The balance sheet shows your current liabilities (short-term debt) and non-current (long-term debt). It lists these debts in order, showing the items you need to repay first.
- Net worth: Assets minus liabilities equals your small business’s net worth. This number includes any invested capital along with retained profits.
- Current ratio: Your current assets divided by your current liabilities equals your current ratio. This figure shows whether your business has enough liquid assets on hand to pay bills in the short term. A ratio of 1.5 or higher usually works, depending on the type of business. A ratio of less than 1 indicates your business may be in danger of not meeting its short-term obligations.
- Quick ratio: The difference between current assets and inventories divided by your current liabilities equals your quick ratio. This figure removes inventory from the current ratio equation for a more conservative view. Most businesses generally regard a quick ratio above 1 as safe.
- Working capital: The difference between current assets and current liabilities equals your working capital. Generally, a positive working capital ratio proves better than a negative one.
- Debt-to-equity ratio: Total liabilities divided by shareholders equity equals your debt-to-equity ratio. This number tells you how much your business relies on debt for operations. Most financial professionals view a low ratio more favourably than a high one.
What Your Income Statement Tells You
Your income statement shows how well your business performs within a specified period of time. It also tells you how much available money you have to pay debt and grow your business.
- Gross profit margin: The difference between revenue and cost of goods sold divided by your revenue equals your gross profit margin. This number provides insight on how well you price your products, helping you better plan markdowns and price increases.
- Net profit: The difference between total revenue and total expenses equals your net profit. This total proves the most important indicator of your business’s financial health. This number shows your company’s bottom line monthly after you pay the bills.
- Net profit margin: The net profit divided by total revenue equals your net profit margin. Converting this total into a ratio breaks down your profit as a percentage of your revenue, which helps you identify trends and predict future profits. For instance, if your revenue for the month totals $20,000 and your expenses (rent, payroll, and production) total $13,000, you have a net profit margin of 35%.
Financial statements help you make informed decisions concerning the future of your small business. QuickBooks Online lets you record all your transactions and gives you the ability to run important financial reports with just a few clicks. 4.3 million customers use QuickBooks. Join them today to help your business thrive for free.