Entrepreneurs often wonder if preparing financial statements is a necessary activity or an indulgence they can postpone to a later time. However, each of the three components of financial statements serves a critical purpose in communicating the financial status of a business: the income statement details the profitability of the business, the balance sheet indicates the business’s net worth, and the cash flow statements describe how cash is generated and used.
What is the purpose of financial statements?
If you’re going to have any productive conversation with a potential investor, lender, or partner, you’ll need up-to-date financial reports. Consider major customers – they may want to assess your company’s financial health prior to engaging in a large-scale contract. In addition, as your company grows, you’ll want to communicate to your employees how the business is faring and how you are making strategic decisions. Finally, you must not forget the need to prepare annual tax returns, which rely on accurate financial reporting.
What information do financial statements provide?
Financials are the foundation of most of the performance metrics by which investors will measure your business. These metrics, as long as they are applied correctly, can give deeper insights into the underlying fundamentals and true momentum of your business and operational efficiency. Accuracy and consistency in preparing those statements are essential to presenting reliable metrics that clearly communicate the profitability and other ratios of your business model that can be used to compare with industry or sector norms.
Having financials is also not just about reporting on past activity – it’s crucial for monitoring progress against previous plans and improving your projections of where your business is going. Management of shareholder expectations is best achieved by presenting a plan and a budget and then reflecting an improved understanding and learning through reporting progress against the plan and updating the budget. Consistent reporting such as this goes a long way in settling the minds of your executives and investors.
In short, prioritize the process of preparing financial statements. In the early days it will be acceptable to have one of the founders or executives reconcile the bank account and credit cards and issue preliminary reports, but as your company grows you need to have a plan (and execute against it) to resource the finance and accounting functions.