Navigating Financial Statements: Comparisons for Powerful Insights
As a small business owner, you might be wondering…
How do I compare financial statements?
Understanding a company's financial health may seem like decoding a complex puzzle, but by unraveling the relationships between the three fundamental financial statements—balance sheet, income statement, and cash flow statement—we can gain valuable insights. Let's review a few simple comparisons to see how changes in one statement ripple through the others.
Comparing the Statements
Example 1: Increase in Sales (Income Statement)
Impact on Cash Flow (Cash Flow Statement): Imagine a bakery sells more cakes. This boosts revenue on the income statement, but the cash flow statement might not see an immediate rise. Why? Because the cash might not have been collected yet.
Analyzing Financial Ratios
Example 2: Paying Off a Loan (Balance Sheet and Cash Flow Statement)
Impact on Ratios: Think of paying off a loan as clearing a debt. This reduces liabilities on the balance sheet, positively impacting ratios. On the cash flow statement, you will see less cash flowing out for interest payments, giving your business a bit more financial breathing room.
Understanding the Relationships
Example 3: Change in Inventory Levels (Balance Sheet and Income Statement)
Impact on Balance Sheet: Imagine a bookstore stocking up on books. This increase in inventory (books on shelves) affects the balance sheet by boosting the asset side (inventory) while reducing cash. On the income statement, it might not directly impact revenue immediately but can affect cost of goods sold (COGS), impacting net income.
Connection to Income Statement: When the bookstore purchases more books (increasing inventory), it doesn't immediately affect sales revenue. However, it impacts the cost of goods sold when those books are eventually sold. Higher inventory levels might indicate unsold goods, leading to higher COGS, and potentially reducing net income.
Monitoring Trends and Patterns
Example 4: Declining Profits (Income Statement)
Impact on Investor Confidence: Picture a lemonade stand selling fewer cups. This decreases revenue on the income statement and might lead to lower retained earnings on the balance sheet. Investors might wonder if it is time to add a new flavor or tweak the recipe.
Financial statements may seem daunting, but by reviewing the comparisons, we uncover a wealth of insights. These examples showcase the interconnectedness of financial statements, demonstrating how changes in one statement can result in changes in the other financial statements.
Understanding these connections empowers small business owners to make more informed financial decisions. By grasping the relationships between these statements, we unveil the story behind the numbers.
