How to read financial statements
Do you know who said, “Accounting is the language of business”? It was one of the most successful businessmen on the planet: Warren Buffett. He went on to say, “To be successful at business, you have to understand the underlying financial values of the business.” Take it from him: reading financial statements is an essential part of being a business owner.
Warren Buffett isn’t the only one who knows that this skill is vital. Financial analysis is one of Tony Robbins’ 7 Forces of Business Mastery, and he brings in experts from every part of business to reinforce this point. Keith Cunningham, a businessman and author with more than 40 years of experience, speaks at Business Mastery, a 5-day live event with Tony that occurs throughout the year and around the world.
Keith is a true business master – he knows what it takes to be successful in business. “Success in anything requires that you understand fundamentals,” he says. “If you can’t read the scoreboard, you don’t know the score, and if you don’t know the score, you can’t tell the winners from the losers.” You must be able to tell whether you’re winning or losing so that you know your next steps – and learning how to read financial statements is a huge part of that knowledge.
Why reading financial statements is important
You probably didn’t start your business because you have a passion for accounting and financial statements. As Keith says, “A lot of people are in love with their idea… The problem is being in love with your idea is not the formula for being successful at business.”
Expert advice is a must-have, and you can – and must – hire a bookkeeper, accountant or CFO to take care of your financials. But you are the one who knows what’s best for your business, and there is still basic financial knowledge you need. When you learn how to read a balance sheet and other financials, you’ll be able to contain your costs, increase your profit margins and be on the front lines of protecting your company from common financial business mistakes.
“Only 50% of business owners get financial statements, and 3% read them,” according to Keith. That means this information will help you surge ahead of your competition.
Components of financial statements
Whether you’re looking at simple recordkeeping for your small business or complex consolidated financial statements, the basics are the same. There are three primary types of financial statements most businesses will report: the balance sheet, income statement and cash flow statement.
- The balance sheet shows assets, liabilities and equity. Risk, liquidity and financial viability can all be determined from this “snapshot” of a company’s finances, making it very useful to investors and creditors.
- The income statement tells you about a company’s profitability. In short, it summarizes all revenues and expenses to come up with “net income,” which is a company’s “bottom line.”
- The cash flow statement provides a summary of receipts and payments – that is, where its money comes from and where it goes. It shows whether a company generates enough cash to operate and pay its debts.
Consolidated financial statements consist of a balance sheet and income statement that are presented as being from one entity, although that entity is made up of multiple smaller ones. This is useful for customers, investors and the business owners themselves to see the conglomerate’s overall financial health.
How to read financial statements
You don’t need to be a mathematical genius or have an accounting certification to be financially literate. Keith Cunningham compares reading financial statements to flying a plane: it takes a bit of learning, but “you wouldn’t want to fly with a pilot who couldn’t read the dials.”
How to read a balance sheet
The most important thing to know when reading a balance sheet is the formula Assets = Liabilities + Shareholder Equity.
- Assets are anything that provides value to your company, including cash, accounts receivable, inventory, buildings or land and patents or copyrights.
- Liabilities are your financial obligations, including interest payments, accounts payable and other debts.
- Shareholder equity is the amount of money left over when you subtract your liabilities from your assets.
In order for your balance sheet to be considered “balanced,” your assets must equal your liabilities plus your shareholder equity.
How to read an income statement
This is one of the most important components of financial statements, because it shows how profitable a company is. The most detailed type of income statement is broken down into the following parts: net sales; cost of sales; gross income; selling, general and administrative expenses (SG&A, or operating expenses); operating income; other income and expenses; pre-tax income and taxes, which all add up to your net income. Real financial pros can also read between the lines to get more information.
- If your sales increased, while your cost of sales decreased, that’s a sign your company is finding efficiencies in its production processes.
- If your operating expenses have decreased as a percentage of your sales, you can be confident your company is being managed efficiently.
- Most income statements also include earnings per share information, which divides your earnings by your number of shares outstanding. This provides a better view of your profitability to shareholders.
How to read a cash flow statement
Elements from the balance sheet and the income statement are used to create the cash flow statement, which includes cash payments and receipts from operating activities, investing activities and financing activities.
- Cash flow from operating activities includes sales of goods and services, wage payments, rent, income tax, interest payments and payments made to suppliers.
- Cash flow from investing activities includes payments made related to mergers and acquisitions, sale of an asset or loans made or received.
- Cash flow from financing activities includes cash that is raised from capital and cash that is paid out due to dividends, stock repurchases and loans.
On the cash flow statement, you’ll see these categories broken down into “additions” and “subtractions,” which together give you the net cash for that category. Add up the net cash, and you have your cash flow at the bottom of the statement.
Learn more about reading financial statements
In order to “pilot your own plane,” you must learn how to read financial statements. Improving your financial literacy is just one of the 7 forces Tony and guest speakers like Keith Cunningham cover at Business Mastery. You’ll learn how to run your business in a way that maximizes growth and profits – and transform it into a lean machine that earns money even when you’re not there.
Ready to take your business to unreached levels?
Discover how to read financial statements properly with Tony Robbins’ 7 Forces of Business Mastery free content series.