Are Standard Financial Statements Adequate for Managing a Business?

Are Standard Financial Statements Adequate for Managing a Business? | Accounting Smarts
Charles Hall

Last updated by

Charles Hall


June 10, 2022

Standard financial statements are an important part of managing a business from an overview perspective.

Standard financial statements are an important part of managing a business from an overview perspective.

These documents show how a company has performed in the past and can also give insight into how the industry may do in the future.

Standard financial statements are not all you need for managing a business. Most businesses also need the guidance of an accountant and a sound business plan to be managed successfully. Companies also need access to financial resources such as investment capital, vendor services, and creditors.

Standard financial statements are a great place to start when managing your business, but they won't tell you everything to know to make decisions moving forward. Keep reading to learn more about the financial documents you need to run a business.

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Table of contents

Standard Financial Statements Used in Managing Businesses

Just using one type of standard financial statement can give you a breakdown of a specific transaction type in your business, such as how much money was made as profit or how much money is owed. Still, each of these inancial statements only gives one part of the overall picture of a company's financial health.

These are the standard financial statements that you'll run into while operating a business (Source: U.S. Securities and Exchange Commission):

  • Balance sheets: A balance sheet is a general overview of the things the company
    owns that have value (assets) and the money that the company owes (liabilities). Balance sheets also work to show the shareholders' equity in the company at a specific point in time.
  • Income statements: Income statements are similar to a balance sheet, except instead of assessing a company's performance as a snapshot in time, it assesses a company's performance over a specific time frame. Income statements are often manifested either annually or quarterly.
  • Cash-flow statements: Cash flow statements explain how financial activities impact a company's cash-flow over a specified time frame. Cash flow statements track operating costs, investments, and other economic costs that affect cash flow and liquid capital.
  • Statements of shareholders' equity: Statements of shareholders' equity are usually assessed annually or quarterly and provide a snapshot of an individual's equity in the company based on the amount of stock they hold.

While these standard financial statements can provide a lot of insight into how a company's finances look, they don't cover everything a business owner needs to look at when managing it.

Along with other documentation needed to steer the business, such as a business plan and mission statement, business owners and managers also need access to resources.

Financial Resources Needed for Managing a Business

Along with the financial statements needed to analyze a company's performance, businesses also need resources that facilitate continued operation and expansion when the finances warrant it. Careful management of a company's finances versus its resources from month to month gives business owners the edge to profit.

 Businesses Need Capital

To manage a business, knowing what money is coming in and going out via financial statements is important, but it's also important to have some money to start with. This startup money is known as the company's capital. Capital is broken up into two basic categories: debts and equity. (Source: Inc)

  • Debts: Debts are capital that a business has gained through borrowing money from another source. Debts are capital with strings attached since they not only require repayment, they usually incur a percentage of interest to pay too.
  • Equity: Equity is capital that has been invested either by the business owner or by stockholders in the company's interests. There is not necessarily a requirement to repay capital that goes into a company's equity, but poor business performance can result in a loss of available equity.

Without capital, businesses don't have the money they need to buy products, payroll, marketing, or any other services needed to run the company. And even though equity doesn't necessarily have to be repaid in full, all capital comes with a working cost.

How Much Capital Is Needed to Manage a Business?

Most small businesses take between two thousand and five thousand dollars to get started up, but that doesn't include the capital needed to manage the business once it's running. The amount of capital necessary for the continued management and operations of a business is called working capital. (Source: Business News Daily)

How Does Working Capital Affect Business Management?

Knowing a company's working capital in detail is crucial to ensuring the company's continued financial health. Without working capital, a business doesn't have the cash reserves to keep itself in operation. Another problem that companies may run into even if they're profitable is that they take on more investment opportunities than their working capital can support.

The way that working capital is managed is usually by assessing a company's financial statements and forming a working capital ratio. This ratio tells the business manager the general proportion of working capital to outgoing costs to give them an idea of whether cash is flowing in the right direction or not. (Source: Investopedia)

What Business Operations Affect Working Capital?

There are many business operations to be managed that can directly affect a company's working capital ratio. Here are a few examples of business dealings that can affect capita (Source: Investopedia):

  • Major investments or projects: Expansions and other company projects often involve a large investment of working capital, which temporarily reduces cash flow into the company. These major investments have to be balanced carefully to ensure they don't strain the amount of working capital available for normal business operations.
  • Dysfunctional collections: If a company is unable or unwilling to collect on outstanding debts that are owed to the company, then this will negatively impact the amount of working capital available. Problems in collections can be insidious since incremental losses in this financial area can have major impacts on a company's bottom line.
  • Reduced sales: Like getting behind on collections, decreasing sales numbers can start small and snowball into a serious cash-flow problem if the effect of reduced sales isn't assessed and addressed in a company quickly. Sales can be assessed through the income statements of a business.

What Is Capital Structure?

In business management, capital structure refers to the proportion of capital that comes from debt or business loans in relation to the amount of capital that comes from shareholder investments. A company's capital structure isn't explained on any standard financial statements and will be different for each company depending on how it is set up.

There are pros and cons of using a debt-heavy capital structure versus an investment-heavy capital structure. Here are some of the ways that business managers determine how to structure their incoming capital:

  • Business risk: The riskier a business is, the less advisable it is for that business to take on debt capital rather than equity capital. Lower debt levels are preferred in risk-heavy industries such as technology.
  • Tax position: Whether a company is better off using debt or equity capital is often determined by the tax laws that govern the company's operations. For businesses with tax-deductible interest, holding capital as debt can be cheaper than having equity that is fully taxable.
  • Financial versatility: Another factor that determines what a company's capital structure looks like is its ability to liquidate assets quickly if necessary. If a business is able to quickly liquidate assets to cover debts in a pinch, it may be more likely to lean into debt-equity.

How Do Businesses Successfully Manage Capital?  

There are several ways that business managers can go out of their way to manage their capital that doesn't involve analyzing their financial statements but can still have a serious impact on the company's overall success.

Here are a few ways that a business manager can manage business capital to increase the worth of the business (Source: SoftCo):

  • Increase ability to liquidate assets: Increasing a company's ability to liquidate its assets quickly increases its working capital ratio.
  • Increase operational efficiency: Whether it's reducing operating costs or managing inventory more rigidly, increasing operational efficiency can lead to increased cash flows due to reduced waste and loss.
  • Increase payment discipline: Paying vendors on time or ahead of schedule allows business managers to snap up early-payment discounts that can help shave operational costs. Just as preventing incremental losses through late collections is important, so is soaking up every possible avenue of saved costs since these savings become profit.

While some aspects of working capital can be addressed by going over financial statements, just having an overview of problem areas in the company's operations won't be enough to protect a company from the negative effects of overspending or lack of collections.

Businesses Need Marketing and Marketing Analysis

Another major aspect of managing a business that doesn't involve analyzing standard financial statements is marketing. There are very few businesses in the world that can operate without a tight marketing campaign. Marketing affects a company's profitability in the following ways:

  • Used to identify buying trends: Financial statements may explain how a company is doing financially, but they don't provide a business manager any indication of how their service or product is doing in the market at large. Identifying buying trends allows companies to plan new products and also strategize how to promote their lineup.
  • Used to generate increased sales revenues: Marketing analysis is used to create leads, and these leads are used to bring in new sales. The proper management of marketing will gradually increase a company's working capital and equity over time.
  • Used to set company strategy: Marketing analysis in business management isn't just an important aspect of managing the company's finances. It also helps set a company's strategy in everything from human resources to structuring. Marketing is usually driven by the company's mission statement and can help strengthen the company brand.
  • Used to generate capital: Marketing isn't just a way for a company to advertise itself to potential customers. Marketing and branding are also used by companies to promote themselves to potential investors. The stronger a company's marketing campaign, the more likely they are to find financial success if all other required factors are in place.
  • Used to retain customers: Marketing may be focused on getting a foot in the door with new customers, but the secret to successfully managing a business is to plan for customer retention and repeat customers. Repeat customers are cultivated by providing a consistent brand while also offering new marketing strategies to draw customers back.

The results of a company's marketing campaign can be deduced from their income and losses presented in standard financial statements. However, there are other kinds of documentation in business management that provide a clearer view of how effective marketing really is.

Marketing campaigns can be one of the most expensive costs a company takes on, but it's also one of the best ways to expand sales. Knowing how to read the results of marketing analysis can go a long way towards making sure the company remains profitable.  

Marketing Documents Needed for Financial Management

Other than standard financial statements, a successful business manager also needs marketing analysis documents that allow them to see a clear overview of how effective or ineffective the company's marketing campaign is and how it can be improved.

Here are some of the marketing documents needed for managing a business:

  • Marketing processes: A document clearly outlining the processes involved in a company's typical in-house marketing campaign can provide a framework for the company's marketing team to take on new marketing challenges as the company grows. Setting up a standard process helps a company's brand remain more consistent too.
  • Marketing proposals: Having a series of marketing proposals on hand allows a company to maintain a constantly-evolving marketing campaign and brand. Marketing proposals should include hard evidence that points to a proposal's predicted success, such as case studies. Marketing proposals should also offer a clear outline of costs.
  • Marketing plans: Marketing plans are similar to marketing proposals, except that they involve the breakdown for the actual marketing campaign rather than predictions about its performance based on influencing factors. The information included in marketing plans includes target demographics, analysis of competitors, and related workflows.  
  • Brand messaging: While marketing plans and proposals address the specifics of marketing campaigns, messaging documentation focuses more on strengthening the message behind a company's brand. A company's brand has to remain consistent to engage customer loyalty despite alterations in products and services.

Why does a business manager need to be able to analyze marketing documentation to manage a business?

Hiring a marketing analyst to explain documentation increases the chances of information being missed, exaggerated, or misunderstood. Understanding how to read marketing analysis directly also allows business managers to contribute their own educated opinions about how to proceed with marketing plans.

The Role of Digital Marketing in Business Management

More and more business managers are hiring customer relationship management experts to help manage the digital footprints of their companies, but it's important for business managers to understand exactly how this aspect of marketing works.

Paying for social media marketing campaigns through a third-party source can be a source of serious financial strain for startups and smaller companies. Small business managers have to carefully balance the benefits of a social media marketing campaign (and the payroll to go with it) against the predicted gains that social media marketing can potentially provide.

Digital media marketing fulfills all of the same roles in a company as traditional marketing. However, digital marketing also opens up the possibility of online sales and online storefronts. For small businesses that are just starting up and can't afford the overhead capital of an office building, being able to start on the Internet and work up from there can be liberating.

There are many digital media marketing firms that have cropped up over the past decade, and these professionals know the ins and outs of setting up websites, generating email newsletters, and other forms of digital marketing that can help increase customer retention and reach new customers.

Without an understanding of how digital media marketing campaigns work and how the results of digital marketing are broken down in statistics, business managers are unable to consistently make judgment calls on the effectiveness of a marketing campaign outside of the bare sales numbers.

Since marketing can have long-term as well as short-term effects, weighing them against financial statements like balance sheets doesn't always give a business manager the full picture of a marketing campaign's effectiveness over time.  

Businesses Need Tax Guidance

Standard financial statements are important for managing a business, but most of the time businesses will also require the help of a third-party tax expert. Even small businesses often involve a number of transactions easier for a tax professional to wrangle than the average small business owner.

Here are some of the benefits of seeking outside tax guidance when managing a business (Source: PDR):

  • Accountants are able to perform levels of financial analysis on financial statements that the average business owner doesn't have the math or statistics to understand. They can then give advice to business managers on how to proceed based on their deep understanding of the company's financial records.
  • Accountants are aware of tax write-offs, loopholes, and other tax benefits a business manager may be eligible for that they wouldn't be aware of to take advantage of without being told. A good accountant can save a business tens of thousands of dollars in deducted tax costs.
  • Accountants can help ensure a business is operating within legal financial statutes. Hiring an accountant to keep the books straight can help prevent a business owner from making a bookkeeping mistake that could potentially cost them a lot of money and trouble with the Internal Revenue Service (IRS).

It's important for business owners and business managers to learn how to read and analyze financial documents as well as they can. However, with all of the other responsibilities designated to a business manager, this level of financial analysis may not be feasible without some outside help.

Documentation Needed for Tax Guidance

Standard Financial statements are among the normal documentation that goes to an accountant or tax professional serving a company, but that isn't the only documentation needed for managing business taxes. Here are some of the other forms of documentation you'll need to hold on to for tax purposes:

  • Bank statements: All bank statements related to a company's business transactions should be filed and maintained for at least seven years in case of an audit. While most bank statements are available digitally, printing out a backup of these statements and keeping a digital backup on a flash drive is always a good idea for redundancy.
  • Payable/receivable invoices: Invoices aren't just a way for accountants to verify your cash flow. They're also a way that business managers can go back and analyze individual sales transactions to identify problems or analyze a sales trend for individual client accounts.
  • Home office expenses: More and more businesses are employing telecommuting workers, and the business manager may end up doing a lot of work from home too. Home office expenses should be logged, and the receipts should be saved for at least three years.
  • Office supply expenses: Many of the office supplies for a business are tax-deductible, so keeping careful receipts and records of purchased office supplies and inventory lists can help with accounting. Tracking these expenses can also naturally deter office waste and theft too.
  • Travel mileage and related vehicle costs: Vehicle mileage is tax-deductible for small businesses and is otherwise known as a "mixed-use asset" since it is used for both personal and business uses.
  • Marketing costs: The costs associated with marketing a company should be carefully calculated and categorized outside of the other costs associated with the business. Any business advertisement counts as tax-deductible, so it should all be carefully recorded and submitted for accounting to increase tax savings.
  • Tax returns: Accountants usually depend on the previous year's tax return as a reference during their analysis, so keeping tax returns for at least three years can help make both a business manager's and the accountant's lives easier when it comes time to reconcile the books for filing season.

All of the above documents are outside of the records generated in standard financial statements, but they're still vital parts of managing a business. Without good tax documentation, business managers miss out on thousands of dollars of missed savings that could be transmuted into company equity.

Other Documents Needed to Manage a Business

Along with standard financial statements, there are several additional types of financial statements that can be used by business managers to help make decisions about how the business should be run. These are a few of the additional documents needed for running a business (Source: Pursuit):

  • Profit and loss statements: Profit and loss statements are a type of balance sheet that explicitly states a company's generated gains and losses within a specific time frame. Profit and loss statements are used in business management to identify "blips" in a company's operational performance and analyze the cause.
  • Accounts receivable/accounts payable: A financial statement that breaks out the amount of money owed in accounts receivable and the amount of money the company owes in accounts payable is a good way to get an idea of the company's working cash flow. It can also point to problems with collections or payment discipline.
  • Facilities documentation: Depending on where a company's primary production and business is located, facilities documentation may play a serious role in the management of the business. Facilities documentation can range from security logbooks to property contract leases.
  • Business license: Many businesses with physical storefronts are forced to display their business license prominently. Certain businesses may require additional licenses depending on the nature of the business conducted, such as a liquor license or a medical license.
  • Competitor analysis: Some competitor analysis falls under marketing, but it's also important for a business manager to review the financial statements and performance of their competitors as well as their rival marketing campaigns. Competitor analysis can determine mergers and inform future business strategy.
  • Financial ratios: Financial ratios are ratios formed from two separate numeric values in a company's financial statement that can be compared with each other to determine an aspect of the company's performance, such as its working capital ratio or loss-to-profit ratio. These ratios can provide a good baseline to determine a company's performance.
  • Budget proposals: Budget proposals are documentation generated based on a company's performance that determines how the company plans to juggle its finances in the upcoming quarter. Budget proposals are created through analysis of financial statements generated from prior financial quarters.

Broad financial statements are a good way to get a bird's-eye view of how a company is performing, but more specific financial documents that cut out certain subsections of profit or loss in a company's operations can give a clearer picture of exactly where the company's money is going, and why.

Financial Statements Are A Small Part of Business Management

Even though the standard financial statements are important for business managers to analyze and consider when making management decisions, these documents only give a skeletal view of how a company is doing.

Reading financial statements alone is not adequate for successfully running a business. Business managers must also understand how to read documentation related to taxes, marketing, and working capital.