So you decided to start a small business and have been going hard for a few months now. The questions come up: do I need to put together financial statements every month? Why are they important? And the answers are, “Yes, definitely!” and “Because then you know for certain where you stand.” Now, I can hear the business owner who says, “I know where I stand all the time; it’s the balance on the bottom line in my checkbook.” Well good for him or her, they know how much money they have in their bank account. But financial statements usually report the balances of numerous accounts. Your checking account is just one of those!
So let’s look at this more closely. Financial statements give you a summary of the effects of all the transactions that your business incurred. Even if as the business owner you complete all the transactions yourself, can you remember them all and know the total effect on your profit (or loss)? Think of the accounting equation: assets – liabilities = owner’s equity. All transactions affect one or more of the elements in this equation. You write a check (an asset) to pay for expenses so you can earn income. You take out a small business loan (a liability) so you have more money to work with. And you complete quite a few more transactions during the month. Then at the end of each month, it’s very important to see a report of your financial position: what are the total assets my business has? What do I owe? How much would I have left if I paid off everything I owe? This information is used in the coming month to make important decisions about the transactions you’ll do.
In conclusion, would you rather know part of the story or the whole story including the ending? Yes, it’s necessary to know the balance in your checkbook. But once a month it’s vital to look at the balances of all your accounts, and the totals of your assets, liabilities, and owner’s equity. Then you are more likely to make the right decisions next month.
Look out for future blogs that focus on the Income Statement and the Statement of Cash Flows!
