Running an online business without knowing how to read a financial statement is like sailing in the dark sea without a map. It's all intuition, and you’ll find yourself pulling numbers from everywhere as if you're a captain looking at the constellations, wondering if the patterns will point you in the right direction.
Learning how to understand financial statements is your weapon to success. Obtaining this skill is like learning how to read a map; when you know how to read one, you can steer your business in the right direction. Let Unloop give you a crash course on how to do it.
The Income Statement
This financial document measures how well the business operates in a given period. This financial reporting tool, also called the profit and loss statement, calculates the total income and expenses and takes the difference between the two to arrive at the net profit—a crucial determinant of a company's financial performance.
Critical Income Statement Accounts
Variable expenses are a big part of the income statement. For most business owners and managers, these expense breakdowns take up much of their effort because, logically, reducing these expenses will bring in more profit. But to get a better insight into income statements, they must watch out for the following critical accounts.
Net Sales / Revenue
This is the revenue after you deduct all the returns and allowances which come from incorrect or damaged orders. The net sales give you an accurate picture of what the business earned in a given period.
Cost of Goods Sold (COGS)
If you produce your own products, the cost of goods sold summarizes all of the expenses you incur while making the products. This cost is calculated on a per unit basis and is attributed to the number of units sold.
The cost of goods sold and cost of sale give you insight into how efficiently you manufacture or sell your products. It can also help you do revenue forecasting.
Gross profit is the amount a company earns from its sales after subtracting the cost of goods sold (COGS). In other words, it is the difference between the net sales or revenue earned and the direct costs of producing or purchasing the goods sold.
Gross profit is a key indicator of a company's financial performance and is used to assess its profitability and efficiency in managing production and inventory costs.
Operating income, or operating profit, is the money a company generates from its daily business course after deducting its operating expenses.
Operating expenses are costs the business incurs as a normal part of doing business, such as salaries, rent, utilities, marketing, and depreciation.
Operating income represents the earnings before deduction of other expenses such as taxes, interest, and other non-operating expenses. It is a key metric to evaluate a company's operational efficiency and profitability.
Net Income After Tax
Also called the net profit, this is a crucial part of the company's income statement. It represents the business's "bottom line" income in a given period.
Net income is what's left after all the expenses and taxes from the business operations have been deducted. The resulting amount also reflects the cash asset on the cash flow statement and balance sheet.
This account is often part of every income statement analysis to determine operational efficiency and profitability.
The Balance Sheet
This is a financial statement sought by many business stakeholders, particularly investors and business executives, as it details the company's value at a given period and expresses it in numbers.
The purpose of the balance sheet is to show the current condition of the company's status through numbers. The balance sheet gives a lot of opportunities for analysis and insight.
Critical Balance Sheet Accounts
In understanding the balance sheet for management or investment purposes, it's essential to know what accounts you should look after when you want to measure your business's value. Here are the critical accounts you must manage.
The cash account is the part of the balance sheet where you will find cash and cash equivalents a company has on hand at a specific point in time. Highly liquid assets such as income from operations, other bank deposits, and money market funds make up this account.
The account provides insight into a company's capacity to fulfill financial obligations in the immediate future. It measures how competent the business is in maintaining its current operations and growth potential.
This account reflects the decrease in the value of high-value, tangible assets. Depreciation operates under the concept that long-term assets such as machinery, equipment, and structures decrease in value over time due to wear and tear. To accurately reflect the value of such assets over time, their original value must be reduced.
Depreciation is a non-cash expense, meaning that cash allotted to cover the decrease in the long-term asset's value stays within the business as a resource for possible future asset purchases. This is why depreciation must be looked after.
This account is part of the balance sheet's liability section and represents the amount owed to suppliers and other vendors from whom the company purchased goods or services on credit.
Accounts payable, concerning the balance sheet, is vital because it's correlated to many possible interpretations. A high accounts payable amount can be interpreted in many ways. It could mean that the business is experiencing a high demand surge, or it could also mean the company is low on liquid assets and is about to shut down.
If accounts payable is the amount the company owes its suppliers, accounts receivable is what your customers owe the business. It's the total credit amount a company gives to its customers for purchasing goods and services without paying cash immediately.
Accounts receivable gives managers and investors insight into the company's capacity to extend credit, but more importantly, its ability to collect them. A high amount of accounts receivable may signify a high risk of writing off bad debts, which may affect the business's value in the long run.
The inventory account in the balance sheet is a current asset representing stock and available for sale. It includes all the raw materials, work-in-progress, and finished goods a company has at hand. A portion of the amount is expensed in the income statement as the cost of goods sold when sales are made.
Inventory in the balance sheet represents how much business value is tied to the goods intended for sale. It will give investors and managers insights into how efficient inventory management is relative to demand.
Arguably the most important account in the balance sheet is equity, often called shareholder's equity. This account represents the value of the business in numbers. It's crucial for executives because it gives them insight into the company's profitability. At the same time, investors look for equity to gain information on whether their investment has increased or decreased in value.
The Cash Flow Statement
The function of the cash flow statement is to monitor the activities of the cash account. The statement of cash flows comprises three sections: financing activities, operating activities, and investing activities. All of which provide a breakdown of cash inflow and outflow.
Critical Parts of the Cash Flow Statement
Cash makes a business run. That's why for managers, this financial statement document is essential. Studying how cash flows in these three basic activities can give them insights into where cash must be channeled for better business performance.
In brief, here are the critical accounts you must watch out for when interpreting cash flow statements.
This pertains to how much cash and cash equivalents the business earned during a period. This will serve as a baseline where you will add or subtract all cash increase and decrease due to business activities.
In the balance sheet section, we mentioned that depreciation is a non-cash expense, which increases the cash balance. The amount of depreciation from the balance sheet reflects the cash flow statement as part of operating activities.
Another account that's part of the operating activities of the cash flow statement is the accounts receivable. In this case, the account measures increase, representing who paid the business in a given period.
In cash flow statement language, the accounts payable represents how much short-term debt the business is lent during the period. Usually, the accounts payable is treated as a cash equivalent as a result of credit purchase for goods and services the business obtained rather than sold.
Unpaid taxes also form part of the cash flow statement's operating activities section. It is included as an increase in cash because it is still money the company can use even if the taxes are yet to be paid.
Inventory is considered a decrease in cash and reflects COGS from the balance sheet. It tells you how much cash you used to produce or acquire the goods for sale.
Understanding Basic Financial Statements Through Collaboration
We've given you a rundown on the three financial statements and the important accounts you must watch out for as you manage your ecommerce business. But to learn how all these accounts play out, you must see how they behave in the ordinary course of your business operations.To do that, you must have a sound accounting system and staff that will provide you with these reports. That's where Unloop comes in. We can give you accurate financial statements monthly, built upon excellent bookkeeping practices. If you're curious about our services, book a call now.