What Are Small Business GAAP Financial Statements & Management Reports?
What every small business owner needs to know…
Editor’s note: This is part two of a three part series. Part 1 is entitled: What’s a Month End Close and Why Does it Matter?
We started this three-part series with “What’s A Month-End Close and Why Does It Matter?”. Part one discussed the importance of the month-end close process, highlighting its role as the first step in the monthly accounting cycle. A process that, when completed, allows management to ask themselves key questions such as, “How did we perform this month?” and “How did we perform year to date?”, which is then followed with strategic management planning structured around the answers to these questions.
The month-end close is crucial as it organizes and reconciles our financial activity for the period. However, this alone does not allow management to answer these questions. To do this, the business must present the information they gathered in a digestible format, and that is done through the creation of GAAP financial statements and management reports. These statements summarize the financial data that was prepared in the month-end close and provides a clear picture of the company’s financial health.
Income Statement
The income statement, also known as the profit & loss statement, provides information on the revenue and expenses of a business. It is the first GAAP financial statement created because it gives insight into the company’s current financial standing and potential profitability.
At the most basic level, it is commonly described as being revenues – expenses = net income/loss. While this may be true, businesses will typically categorize their expenses to get a more in-depth analysis of how they are performing. Some examples of what the business may be able to determine through this categorization of expenses include their gross profit, operating profit, and EBITDA. All of which provide key insights into the company and what can be done to drive further growth.
Balance Sheet
The balance sheet is the next GAAP financial statement to be completed, as it provides an overview of the company’s assets, liabilities, and equity. It follows what is known as the accounting equation, which states that assets must equal liabilities plus equity.
While the income statement tells us about the company’s performance, the balance sheet tells us about what the company owns versus what it owes. For this reason, it can be used to determine the financial health of the company.
Management Reports
Besides these two typical financial statements, the business owner can also create management reports from the information gathered in our monthly-end close. These are generated for internal use only, and therefore, are highly configurable and do not need to follow GAAP standards.
Many kinds of management reports can be generated to assist management in making informed decisions. While the income statement and balance sheet provide general oversight of the company’s health, management reports will fill in any gaps in information. Some examples of management reports include cash flow forecasts, budget reports, and operational reports.
Real World Examples
- A client has been able to succeed and flourish in a capital-intensive industry – Printing. Their success, however, stems from their financial controller, who produces strong GAAP financial statements and management reports following the month-end close. Using these financial statements and management reports has been the key to the company’s ability to effectively plan over the years and continue to grow.
- Many clients and businesses can effectively plan because they are aware of their gross profit margin. However, this can only be ascertained by a strong month close that leads to the creation of GAAP financial statements. Knowing the gross profit margin of a business is extremely important for the business owner. It enables the ability to project and budget for fixed costs and the necessary investments that the business might require for the future.
Conclusion
With the preparation of GAAP financial statements and management reports derived from a strong month-end close, the business can provide management with the tools they need. These financial statements are the foundation that allows management to ask, “How did we perform this month?” and “How did we perform year to date?”. In the last article of this three-part series, we will take a deeper dive into these questions and other strategies management can use to effectively plan to achieve its objectives and ultimately optimize cash flow.
Frederick Schildwachter contributed to this Alex Hart article.
Related content:
Part 1: What’s a Month End Close and Why Does it Matter?
8 Recommendations for Safeguarding Cash Flow
In Uncertain Times, Focus on the Fundamentals for a Profitable Business
Requisites for Good Financial Management for Small Businesses