Let’s accept it, finance and accounts are not everyone’s cup of tea. Many people struggle with it and some plainly avoid it. However, if you are a founder of an early stage company, avoiding financial statements is not something you can afford to do.
You can hire an accountant or a CA firm to get your business in order but financial statements are the window to the financial health of your company. Going through them can give you many business insights like how much money you are spending to acquire clients or trends in payments and areas where your business is bleeding money. If you are planning to raise investments through bank loans or VC’s, you definitely can’t ignore them as inconsistencies can be a deal breaker.
In the First Edition of Blincubator we had Nitesh Todi who spoke about various financial statements and through this article we decode 3 basic financial statements 1) Income statement 2) Balance sheet 3)Statement of Cash Flow that every company needs to maintain. These financial statements are calculated on the accrual basis, which means the reporting is done when the transaction occurs irrespective of the cash being paid or not.
1)Income Statement aka Profit and Loss statement(P&L): Plainly put P&L records business’s income and expenses to calculate the profit for a specific period of time. It has two major elements Income (i.e Sales Revenue) and Expenses
Income includes revenue from the sale of product/service and interest on loan given. Although there can be other sources of income for a company, mostly this should be the revenue generated from the sale of your key product or service
Expenses: are expenditure incurred for making the product or selling them. There are two kinds of expenses a company makes direct and indirect. Direct expenses are cost that are directly incurred during the production of the product example raw material, the wages of labor, warehouse. Indirect costs, on the other hand, do not occur during the process of manufacturing, but rather before or after the manufacturing example general and administration or rent for the showroom
2) Balance Sheet
Unlike the income statement which is related to the transaction of expenses and income, the balance sheet shows assets, liabilities and shareholder’s equity of the company.
- Assets are property (physical and monetary) possessed by the company including real estate, plant, equipment, and machinery.
- Liabilities are the obligation that the company has to take care of. These can be payment of loan, suppliers or other pre-received income.
- Shareholder’s equity: These are the amount that the owner invests in the company including assets that they bring with them.
The total amount of the assets has to equal the amount of liability and shareholders’ equity. If it does not, then there has been an error of recording, wrong figure or adjustment.
3)Statement of Cash Flow
This financial statement is related just to the inflow and outflow of the cash from the business. This is done in order to calculate the amount of cash that has been used by the different activities or the usage and inflow of cash for the various activities. There are typically three types of activities:
- Cash flow from operating activities: these include the activities related to the routine activities of the business. This includes income from sales, payment to short term suppliers or the receipt from debtors.
- Cash flow from investing activities: This includes any cash influx that has resulted due to investment in any assets like machinery, buildings, or invest in shares and give loan to other parties
- Cash flow from financing activities: On the contrary, if the cash is being transacted for funding the company. Borrowing any money from the bank or the lenders, issuing share capital or bonds, paying the dividend all fall under financing activities.
About the resource person
Nitesh has over 8 years of experience in the field of audit, tax, and advisory across non-profit, hospitality, health-care, hydropower, manufacturing and telecom. He is also involved in several assignments for International funding agencies such as the European Commission, World Bank, UNDP, DFID.
This blog is excerpts from the training session conducted by Nitesh Todi on Finance and is part of the BLincubator series that is published each week. It summarizes key learning from the training sessions of the program.