Why are financial statements useful for startups?
Updated: Jun 20, 2020
Financial Statements are decision-making tools. They are necessary to get business loans, identify trends, monitor receivables, analyze debts, identify cash flow problems, and much more.
Reviewing financial statements helps startups and small businesses better plan for the future, which ultimately leads to business success. The analysis of financial statements is an important part of the long-term strategy for any startup that wants to guarantee the sustainability of their activities.
The main purpose of financial statements is to provide a summary of the financial health and performance of the business. This information is relevant to stakeholders in order to make better operating, financing and investing decisions.
Let’s go over the reasons why startups should care about the 3 most common financial statements.
The income statement provides details on the resulting profit or loss of the company. The result represents the difference between the company's revenues and expenses over a period of time.
We recommend startups to review the income statement at least once a month. This helps the company to optimize its expenses and increase its profit. Additionally, a properly maintained income statement will make it easier to perform tax planning. The income statement’s information is the basis for the calculation of taxable income which is necessary to determine the taxes that a company has to pay.
Startups can prepare a Pro Forma income statement which is an estimated income statement into the future. The Pro Froma statement requires the agreement of sales projections, production schedules, expense estimates and the estimated expected profit. This projection helps management make important decisions regarding marketing, suppliers, employees, etc. which will lead to the strategic objectives of the company.
The Pro forma income statement is usually required for startups when applying for a loan, because it provides to the lender the possibility to estimate the relevance of any new business project and its capacity to pay off the requested loan.
Cash flow statement
The cash flow statement gives a clear picture of how a company earns and spends its cash. This statement is split into 3 categories which are operating activities, financing activities and investing activities.
Analyzing the cash flow statement is an easy way to figure out if a company has a cash flow problem. Generally, a well balanced company will have an operating cash flow that is similar to the net income from the income statement.
By their nature, startups are facing cash flow problems, that’s why it’s necessary to give more importance to the preparation of the cash flow statement. Startups should pay attention to a negative operating cash flow as this number must become positive for the startup to see any chance of success.
The investing cash flow will naturally turn negative when assets are purchased to support growth strategies. It’s important to see revenues grow shortly after spending cash on operating activities.
Startups generally raise money by issuing debt or equity to investors. Financing activities will provide clarity on how much cash is received from investors and the outflow of cash used to repay debt.
The balance sheet provides a snapshot of a company’s assets, liabilities and equity, which gives an idea of the overall financial health. The information from a balance sheet helps manager’s calculate key financial ratios such as working capital ratio and debt equity ratio, which should become common language for any startup owner.
Also called the statement of financial position, the balance sheet is essentially a picture of what a company owns and owes, as well as the amount invested by shareholders. Managers will want to take strategic action to ensure their business has an asset to debt ratio higher than 1.
A good standing balance sheet is required by banks and investors before getting approved for financing. It will give investors an idea as to how much debt or equity the company is able to handle without the risk of non-repayment. A Pro Forma balance sheet is a great way to understand how a company will be financing its assets using debt and equity in the near future.
As with all other financial statements, we recommend startups maintain projections (pro forma financial statements) and compare to them at least once a quarter.
Maintaining financial statements is a necessity for all startups and small businesses, not just to comply with the accounting rules but also to ensure a good understanding of the financial health of the company. Don’t assume you can analyze your financials in 5 minutes. Proper analysis & planning can take several days and multiple meetings.
ReInvestWealth can help automate the preparation of financial statements through a proactive cloud accounting software that eliminates manual work. Our team of CPAs provides business insight using data analytics in order to increase your probability of long-term growth.
If you need accounting support simply send us an email at email@example.com or schedule an appointment on our website www.reinvestwealth.com. We are ready to help with any questions by providing a free consultation.