Financial statements is a vital pillar in understanding the health of your business’s finances. It’s important for entrepreneurs to know how to build financial statements because it provides insight into two critical aspects:
- They display the historical financial landscape of your business to make decisions in the present
- They help forecast the future growth of the company
In other words, it is the benchmark of your company’s overall financial performance today and tomorrow. For residential home service business owners, financial statements provide a detailed look into the company’s financial position. Financial statements can help you make sound future decisions on your business.
There are three kinds of financial statements:
- The balance sheet (statement of financial position)
- The income statement (profit and loss statement)
- The cash flow statement (flow of funds statement)
Each one tells a different story about your company’s financials. But they all work together to give you a comprehensive overview.
Here, we’ll examine what each financial statement is and the important building blocks that comprise each one. Finally, we’ll talk about how to create a financial plan for your residential home service business.
What are Financial Statements?
A financial statement is one of 3 primary financial reports that gives you an overview of your company’s financial health and performance. They show how much money is entering, going out and being held by your business.
For example, every time a customer pays you for the goods and services rendered, that’s revenue coming into your business. On the other hand, the money used to pay your Techs are expenses going out of your business. The money left over, along with the capital investments you make to have the business work are your profit and equity. All of this information comes into play when making financial statements.
The information is recorded by the business and then audited by accounting firms and government agencies. They ensure the accuracy of the data indicated and determine what money is owed and where it must be sent. Financial statements are essential to pay tax, payroll, credit, and build a warchest for the bad times.
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Major Types of Financial Statements
Knowing how to write a financial statement isn’t simply for formality. It’s more than a barometer for financial health. Financial statements are used by investors, creditors, auditors, and even market analysts to evaluate your business’s earning potential and financial health.
More importantly, your financial statement is important for client confidence. Customers will always choose to work with a financially stable business, especially in the services industry. While not required to disclose, a solid set of financial statements is an assurance that you are running your business credibility.
On the other hand, competitors would also love to get their hands on the financial status of a competing company. Knowing how competitors are performing would allow you to recalibrate your business tactics. For example, if competitors are hanging on by a thread, offering irresistible value to your mutual prospects could edge them out of the marketplace.
There are three major financial statements: the balance sheet, the income statement, and the cash flow statement. We’ll learn about each financial statement below.
The balance sheet is a financial statement that reports a company’s liabilities, assets and shareholders’ equity at a specific moment in time. Normally, this snapshot is taken at the end of a reporting period. The balance sheet can be used to derive important financial ratios that give insights into a company’s financial health.
Below, you’ll find the breakdown of the balance sheet:
- Liquid assets –These are cash and cash equivalents including commercial paper, short-term government bonds, and Treasury bills
- Account receivables – These are the money owed by your customers for services rendered by your business.
- Inventory – This includes the cost of your materials and equipment you have in stock. Air conditioners, refrigerant, and pipe are examples of inventory for an HVAC company.
- Account payables – These are the money owed to your customers, suppliers, or government for services rendered to your business.
- Accrued payroll – Payable wages to employees and techs.
- Debts – Covering both short-term and long-term debt.
- Dividends – owed to shareholders.
- Total assets minus total liabilities – The value would be the amount distributed to stockholders if the assets are liquidated and debts are paid.
- Retained earnings – These are a portion of the shareholders’ equity. They are the earnings not distributed as dividends to shareholders but are retained for the company’s use.
Like the balance sheet, the income statement covers a specific time frame. Every month, quarter, and year, you want to review and interpret your income statement. The income statement is the financial statement that provides insight into the business’s revenues, fixed and variable expenses, and net income. This data is also used to determine the earnings per share.
Revenue can either come from operating revenue or non-operating. As the name suggests, operating revenue is earned by selling your products or services. For a plumber, operating revenue would be from the charges of repairing sewer lines, as an example. Non-operating revenue, on the other hand, is not related to the main business operations. Some examples could be the interest earned from bank holdings or selling an old piece of capital equipment.
Expenses, like revenue, also come from various sources. The two primary expense categories are the ones incurred during the revenue-earning operations of a business. In the residential home service, this covers the variable costs of the sale known as the cost of goods sold (COGS), and the fixed expenses that stay relatively static for running the operation.
Typical COGS expenses in HVAC include Tech and intaller salary, sales commissions, equipment and materials, finance charges including credit card fees, services and subcontractors, and necessary installation permits. Fixed expenditure include human resource and manager/administrative payroll, advertising, fleet, facility, and general expenses like equipment, phones, software subscriptions, and training.
Statement of Cash Flow
Otherwise known as a Cash Flow Statement (CFS), this financial statement is a measure of how well a company collects cash to cover immediate expenses like payroll and sets up excess to facilitate profitability.
The CFS is a tool used daily, weekly, and monthly to stay cognizant of the immediate cash needs of the business.
The CFS is particularly important for owners and potential investors. It reveals how company operations are running, where the cash comes from and how they spend the money in priority. A good CFS normally indicates equally solid financial statements in the balance sheet and income statement.
Calculating the cash flow statement is not formula-based. Businesses normally use the three sections below to report the cash flow:
- Operating Activities. This covers the sources of cash and how it was used for business operations. Operating activities include actual cash received or spent from accounts receivable, inventory, accounts payable like wages, income tax and rent, among others.
- Investing Activities. This entails actual cash received or spent from the business’s investments, like interest, dividends, or foriegn exchange. This includes using money to buy capital assets like trucks or heavy machinery.
- Financing Activities. This includes sources of cash given by banks or investors, including the uses of cash paid to shareholders. An organization’s financing activities include debt and equity issuance, loans, stock repurchases, payments of shareholder dividends and repayment of shareholder loans.
Important Elements Included In Your Financial Statements
Financial statement reports are meant to demonstrate the overall health, activity, performance, and trajectory of your business. The main purpose is to let investors and creditors know if your company is worth the investment.
To make financial statements useful to stakeholders, you should use the accepted language know as GAAP, the generally accepted accounting principles. This means integrating the essential elements into these documents. This makes it easier for potential creditors and investors to navigate through your business’s finances. Plus, this will help them compare how you’re faring versus the industry standard financial statements.
Here are the elements you must include and never miss when making financial statements:
Investments should cover all the money you’ve put into the business. Also, this should cover the increase in net assets as a result of transfer from other entities into your enterprise. How much they’ve extended to obtain or at least increase equity or ownership in the biz.
Liabilities must include all financial obligations of the business – both short and long term. This will demonstrate what the business owes and is obligated to pay for. Moreover, liabilities are also the possible sacrifices of benefits from current operations. This may be due to a mishap in past transactions or events. Nevertheless, the sacrifices are meant to ensure the longevity of the business.
Losses are defined as any decrease in equity of the enterprise (from shareholders and/or owners). This may be other than those resulting from financial investments or distributions. These losses can be a result of operational decisions, financial irregularities, or other external/internal factors.
These are the inflows, improvements of assets and settlement of business liabilities for a certain period. These revenue streams are obtained through the continuous delivery of quality products and the rendering of impressive business operations.
Assets are all the resources of an enterprise that will generate future economic benefits. Aside from that, assets may also cover forecasted economic benefits that are obtained or managed by external entities.
- Comprehensive income
Comprehensive income is the change in equity or net assets during a period. This may be a result of transactions, events, and other circumstances of external sources. All equity changes during a period are included except those resulting from owner investments and distributions.
- Distributions to owners
Decreases in net assets due to the transfer of assets, rendering of services or liabilities incurred. Ownership interests decrease when owners receive distributions.
Equity is the profit left after all the liabilities are deducted. In a business, the equity is equal to the ownership interest.
The outflow or the use of assets in a company during a period from delivery of goods or rendering of services. The expenses are commonly the fees rendered to fire up your business’ central operations.
Gains are the increase in equity or net assets of a company during a period from peripheral or ancillary transactions. Gains are usually isolated and non-operational. They are obtained from all other dealings excluding those from revenues and investments by the owner.
How To Write an Effective Financial Plan for Home Services Business
Financial planning or what others call forecasting provides the view of your enterprise today going into the future. Planning is a necessary component of any business, including home services businesses. Drafting a financial plan helps business owners allocate resources, set financial goals, and make financial projections.
One good thing to remember is that you don’t create the financials in a business plan the way you compute the particulars in accounting reports. The purpose of financials in your business plan is two-pronged:
- First, the information is needed by your investors and other entities with financial stakes in your business.
- Second, you use the financial plan as a blueprint to predict your home service business’s future performance in a bid to plan capacity.
Here are the steps in creating a financial plan for your residential home service business:
STEP 1: Create a Spreadsheet Projecting your Sales
The first step is making a sales forecast using the spreadsheet. The spreadsheet is supposed to project the sales from your goods and services over the course of the next 3 years. In the first year, you should have sections for various lines of sales and designated columns for every month. In the second and third years, you can have these sections and columns on a quarterly basis.
Create three blocks in the spreadsheet. The first block must be dedicated for unit sales while the second one for pricing. The third block must multiply the unit by the cost to come up with the cost of goods sold. You’ll require the cost of goods sold from your business forecast to compute the gross margin. The gross margin is calculated by subtracting sales by the cost of goods sold.
STEP 2: Make a Spending Plan for Your Expenses
The sales forecast is only one piece of a big puzzle. You need to know how much the cost is to make the sales you’ve previously forecasted. In this section, consider the fixed costs and variable costs you’ll be spending.
Fixed costs cover expenses like rent, payroll, phone, office supplies, advertising, fleet expenses, and the internet. These are expenses that are typically the same every month. Using these numbers, you can estimate other expendatures like interest and taxes. Multiply your estimated profits by the predicted tax percentage rate to gauge your taxes. Then to estimate interest, multiply your debt balance by the interest rate.
All of these expenses can be compared against industry norms so you can plan on how much to spend in different areas like fleets and marketing. Once you have a clear understanding of your projected budgets and how they change with growth and contractions, you can prepare cash flow projections.
STEP 3: Prepare Cash Flow Statement
Your cash flow statement will show how much money is flowing in and out of your business. You’ll base the CFS on the sales forecast you previously prepare, including the balance sheet items and other important assumptions. The only way you can project your cash flow is through existing financial statements.
If you’re a new business, projected cash flow is distributed over 12 months. There are aspects you need to know to do this, for example, your invoicing and collection process. Will customers pay right away or within 1-3 months? Knowing the consistency of their payment schedules will help build your CFS.
STEP 4: Net Profit Calculation (Projection)
This step is simply perfunctory or carried out to project your profit and loss (P&L) statement for the following three years. Use the numbers you inserted in the sales forecast (step 1), expenses (step 2) and CFS (step 3). EBITDA net profit is calculated by subtracting the gross margin by operating expenses, before interest, taxes, depreciation, and amortization are taken into account.
STEP 5: Manage Assets and Liabilities
You have to identify the assets and liabilities that are not covered in your P&L statement. This will help you in projecting the net worth of your residential home service business by the end of the Fiscal Year. A few examples of these assets are the value of your capital equipment and the inventory on hand in your facility.
Keep track of your cash flow month-to-month. This includes receivables (the money owed to you), inventory (owned by you), land, capital equipment, and buildings. The next step is to compute your liabilities, including accounts payables (money owed by your company) and loan repayment obligations.
STEP 6: Break-Even Analysis
The three-year income projection you prepare must help you deduce the breakeven point of your business. You reach the breakeven point when your business expenses equal your sales revenue. For a home service provider, this means you have covered all of the costs linked with service rendered. You are now generating a profit when your sales exceed costs.
A business is considered viable and healthy when its overall revenue outweighs the expenses. These are important pieces of information that are valuable for investors and stakeholders. veryone want to be assured that they’re investing in a company that’s actively growing, stable, and healthy. Moreover, an exit strategy is also important for them.
Building a financial statement in your residential home service business is not as complicated as it first appears. By understanding basic accounting concepts and using the right tools, you can easily create financial statements for your business. Doing so will give you a clear vision of your financial health and help make better decisions for your business.