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E-Myth – “Why most small businesses don’t work & what to do about it”

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Edmonton CPA | understanding the various components of financial statements

If entrepreneurs do not understand all of the various components of their financial statements, Edmonton CPA says they may end up making big mistakes on their financial decisions. In fact, a study was done by Intuit’s, the makers of QuickBooks asking entrepreneurs their understanding of basic business finances. 82% of the respondents scored less than 70% on the test. This shows that many entrepreneurs have large knowledge gaps that can contribute to mistakes being made.

The first thing that business owners should understand, when their Edmonton CPA references their financial statements, they are talking about 3 different reports as a whole. These 3 reports are the income statement, the balance sheet and the statement of retained earnings. While many entrepreneurs are very familiar with the information on their income statement, it is important that a business owner understands not just income statement, but all of the reports because that will allow them to see the whole financial picture of their business instead of just parked.

In fact, entrepreneurs should resist looking at the income statement first, and instead look at the balance sheet. The reason why this is important, is because the balance sheet shows all of the assets and liabilities for a business as a whole. This will allow entrepreneurs to gain an understanding of what the financial position of their business is. The balance sheets will have a section at the very top listing all of the assets of the business, below that will have a list of all of the liabilities. The last section on the balance sheet shows the equity of a business. A business owner should be able to add the liability and the equity up to equal the assets of a corporation. This is why it is called a balance sheet.

Next, the income statement should be read and understood and then compared to the balance sheet in order to make financial decision. Since the income statement shows the revenue generated for a specific time period, entrepreneurs should avoid trying to make financial decisions based on this. No matter how profitable the income statement for this time. Shows, or not, that does not necessarily mean that is how well off or not the business itself is doing. However, it is very important for business owners to consider the revenue generated in that time frame in addition to the overall financial health of the business.

Finally, the statement of retained earnings is an important document that business owners should look at when they are earning dividends in their business, or if they are paying them out. Since this is the statement that shows all of the retained earnings that were left in the corporation, it is important to see prior to dispersing them.

When entrepreneurs are able to read and understand all of their financial statement component parts, they will be able to make more informed financial decisions. 10 CPA says the sooner that entrepreneurs can do this, the better since business owners face a high failure rate in business, the sooner business owners can learn the skills that they need to make better decisions, the more likely they will be able to beat those odds.

Edmonton CPA | understanding the various components of financial statements

One statistic that is extremely important to understand says Edmonton CPA is the percentage of entrepreneurs that fail in business. 15% fail in year one, 30% fail in year 2, and 50% have failed by their 5th year in business. One of the reasons why entrepreneurs fail in business, is because they ran out of money. In fact, 29% of all businesses that fail in depth saying that running out of money was the contributing factor. Business owners can avoid running out of money in their business if they can read and understand their financial statements, and make more informed financial decisions.

One mistake that many entrepreneurs often make, is that they look at their income statement first, or they look at it only when there making their decisions. This is a huge mistake, because the income statement shows the net income or net loss of a specific time period. But that does not necessarily mean that what is represented on the income statement shows the entire financial well-being of the business. Edmonton CPA says in order to understand why businesses should not look at this first, they should understand what the report looks like and what the information is saying.

When looking at an income statement, entrepreneurs should see that there is revenue listed at the top, for every product or service that they sold. Below that, Edmonton CPA says there will be a list of all of the direct cost of sales. This means any subcontractors that were hired to produce the product or service, any employees whose sole responsibility is working on those products or services and any materials that were purchased specifically to generate that product or service. Underneath that, while show a total of the gross profit which is the revenue minus the direct cost of sales. Underneath that, will be a listing of all of the general expenses. These are the expenses that are incurred whether or not an entrepreneur has sold anything. These expenses are things like rent, utilities, office supplies and administrative staff salary. These are often the largest expenses that the business will incur. Underneath that, will have all of listing of the net income or the net loss that the business experienced.

Because this shows the revenue that was generated and the net income or net loss of a specific timeframe, that does not necessarily mean the business is mimicking the net income or net loss represented on the income statement. For example, an extremely profitable income statement might mean that there are a lot of assets in the business, but it also might mean that all of the income that was generated in that timeframe simply paid off a lot of the liabilities of the corporation. Therefore it is very important that entrepreneurs look at the balance sheet first, and then the income statement alongside the balance sheet to gain a complete understanding of the finances of the business.

When entrepreneurs want to be able to make informed business decision, Edmonton CPA says that they should learn how to read each of the component parts of the financial statements, the balance sheet, income statement and statement of retained earnings. Understanding all of these reports, and then how to use them and making financial decisions can significantly help entrepreneurs overcome the 50% failure rate that entrepreneurs face in Canada.