Contrary to the belief that most businesses fail within the first year, statistics from the Small Business Administration show that 80% of small startups survive. However, the number drops drastically, with only 45% to 51% of these businesses living up to the five-year mark. Only one in three small startups will be open in 10 years.
Though these statistics might be discouraging, identifying the key causes of business failure allows entrepreneurs to make sound decisions. The failure of small businesses is mostly attributed to inadequate funding, bad management, and poor planning. Lack of proper financial records is mostly a result of poor planning and bad management. This post provides you with insights on what financial records small businesses need to keep.
Financial records for small businesses
In spite of its size, running a small business involves quite a lot of paperwork. Keeping proper financial documents enables you to keep track of the business’s revenue and expenses and to monitor your business’s progress. You need these accounting documents to file your taxes and, when necessary, apply for financing. The main financial records a small business should maintain include the following.
A balance sheet gives the business owner an idea of the business’s financial standing. It details the business’s assets, liabilities, and owners’ equity, thus providing insights on what the business owns vs. what it owes. A balance sheet is normally prepared at the close of a reporting period, such as the end of a fiscal year. A balance sheet’s outline reflects the following equation:
The assets are divided into current and long-term assets. Current assets include cash and accounts receivable. Long-term assets include buildings, land, office equipment and machinery, and the organization’s vehicles.
The liabilities and owners’ equity tabulate all obligations and debts the small business owes besides its vendors, creditors, and lenders that should be paid within the current fiscal year.
Also known as a profit and loss statement, an income statement summarizes the business’s profit or loss for a particular timeframe. An income statement may be prepared monthly, quarterly, or annually.
An income statement tracks the business’s revenues and expenses so to determine its performance over that period. An income statement includes the following elements:
- Sales — the total revenue generated by the small business minus any sales discounts and product returns.
- Cost of goods or service — the expenses directly associated with manufacturing products or acquiring them from suppliers; if your business provides a service, this figure includes employees’ salaries and benefits.
- Gross profit — net sales minus the cost of goods or services from the net sales.
- Operational expenses — the day-to-day costs of operating the business, which can be divided into administrative expenses and those associated with marketing and selling your products or services, and may include utilities, rent, office wages, advertising, collateral and promotions, depreciation, and overhead costs.
- Total expenses — all expenses incurred when running your business, exclusive of any interests on interest income or taxes.
- Net income before taxes — gross profit minus operational expenses.
- Taxes — the amount you owe the federal, state, or local government in the form of income tax.
- Net income — the final figure that your small business earns after you pay your income taxes.
Cash flow statement
A cash flow statement documents all the money that flows in and out of the business. This can help the business owner see whether the business is making profits or losses. Cash flow activities are divided into three categories: financing, investing, and operational activities.
Financing activities include all the flow of money from creditors and shareholders’ equity meant for financing the small business. Cash flow on investing activities refers to the money the small business gains or losses from such activities as buying or selling an asset. Operational activities are the daily expenses involved in running the business.
The cash flow statement can be either negative or positive. Negative cash flow indicates that you are spending more than you are earning. You can remedy this by coming up with ways to generate more revenue or cut down on operational costs. In the event of positive cash flow, you are in a healthy financial standing to expand your small business. Proper bookkeeping is not an option, even for small businesses. Apart from providing insights on your business’s financial standing, these three documents come in handy when you apply for loans. Investors also use these documents when deciding on whether they should invest in your business.