Know How Your Money Flows: Financial Statement Effects of Business ActivitiesNov 10, 2020
It’s a tale as old as time; a new business opens, the money starts coming in, and the expenses start going out. Sounds simple, right? However, it would behoove all business owners to know not all cash inflows/outflows are the same. Not all inflows mean more income, and not all outflows mean higher expenses.
Profit and Loss vs. Balance Sheet
Depending on the nature of the transaction, cashflows may be “absorbed” by a business in two ways:
- On the Profit & Loss Statement
- On the Balance Sheet
A Profit & Loss Statement summarizes businesses’ revenues, costs, and expenses over a time period. Examples of the transactions that flow to this statement are receiving money for goods and services, purchasing material necessary to do business, research and development expenses, payroll costs, and other expenses related to running the business. A Profit and Loss can detail how much money was generated from and used for business operations. These inflows/outflows have a direct effect on the Net Income of the company.
A Balance Sheet Statement reports a company’s assets, liabilities, and shareholder’s equity at a specific point in time. It is a financial statement that provides a snapshot of what the business owns and owes, as well as the amount invested by shareholders. Transactions that flow to this statement include accepting a business loan, making a credit card payment, purchasing an asset, and receiving loans from (and making payments to) shareholders. A Balance Sheet can give an idea of the business’s value and how much money it uses to increase it. These inflows/outflows do not have a direct effect on the Net Income of the company.
Statement of Cash Flows
I know what you’re wondering. Isn’t there a document that can summarize my business operations and tell me where my cash went?! Please allow me to introduce your financial statement wingman, the Statement of Cashflows. It is a financial statement that provides information regarding all cash inflows a company receives from its ongoing operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period. It ties the Profit & Loss to the Balance Sheet together and shows how the cash is being spent. The transactions are categorized into three groups:
- Operating activities: The Net Income (from Profit and Loss) shows how much cash was generated or spent from operating activities. Balance sheet transactions that affected cash relating to operating activities will also be listed here, such as accounts and loans payable.
- Investing activities: Reports how much cash has been generated or spent from various investment-related activities. Investing activities include purchases of assets, investments in securities, or the sale of securities or assets.
- Financing activities: Reports the net flows of cash that are used to fund the business. Financing activities include transactions involving debt, equity, and dividends.
Understanding these statements and how your business operations affect them can help you identify strengths that should be capitalized on and weaknesses that should be addressed. I would recommend that owners get into the habit of analyzing these documents on a quarterly or monthly basis. However, be forewarned that these reports are only as accurate as of the information that created them. Ensure your financial data is being recorded accurately and timely to prevent yourself from missing out on key opportunities for business improvement. A great way to stay current on your financial reporting and receive real-time guidance is to hire an Accounting Professional.