Source: Image of accounting ledger, dollar sign, block arrow, images by Video Scribe, License held by Jeff Carroll; Image of storefront, Public Domain, http://bit.ly/1l51GoG.
Hi. I'm Jeff. And in this lesson, we'll learn about the role of financial planning in an organization. And we'll review the three different types of financial statements. So let's get started.
Why is it important to have a financial plan? One reason is that a key factor for small business failure is the lack of a realistic financial plan. So it's critical to perform the research and analysis necessary to develop a financial plan. This should involve a comparison of the current financial statements as they relate it to the business's goals, a projection of upcoming requirements, and an analysis of the risk involved in the business's future.
A financial plan will often contain three common financial sections. And we'll discuss those next. The first of these reports is a balance sheet. This is a ledger that compiles the holdings liabilities and funds laying out the income and expenditures of an organization during a specific point in time.
Here is an example of a balance sheet. This gives a snapshot of the company's current financial condition. It has specific detail on assets which are items that are solid such as a building or abstracts, such as a brand that can produce value and/or add monetary value.
Assets include current assets, which are all cash and anything that can be converted into cash within one year, which is known as liquidity and fixed assets, which include items such as land, building, equipment, and anything else of long-term value. These are also items that can decrease in value, because they can wear out. That is known as depreciation and should be tracked also.
And it also includes intangible assets, which are assets that might produce monetary value in the future, such as patents, copyrights, goodwill, and brand recognition. A balance sheet also lists liabilities, which is an item that is a present burden. These include current liabilities, which are debts that must be paid within one year and long-term liabilities, which are debts that can be paid in longer than one year.
Finally, a balance sheet can include a report on owner's equity. This is a mathematical formula indicating the owners contribution to the organization minus the liabilities of the organization. This shows whether a company is relying too heavily on debt for its growth. The reason it is known as a balance sheet is because the accounting equation A equals L plus OE must balance out. This means that assets is equal to the liabilities plus the owner's equity.
The second financial section a financial plan might include is an income statement, which is a report reflecting the income, sometimes known as R for revenue minus the expenses known as E for a set period of time. Here is an example of an income statement. This can also be referred to as the profit and loss statement. And it shows the bottom line for a company, whether it's making money or not.
It also allows an investor to note how the company is performing currently versus a previous quarter or previous year. An income statement will include revenues, which is the money acquired by an organization during a specific period of time, Cost Of Goods Sold or COGS, how much money did the company spend to make the goods and bring them to market, and operating expenses or OE-- what were any additional expenses incurred outside of the production of an actual item? The income statement equation is revenue minus expenses equals the profit or loss.
The third financial section included in a financial plan is the statement of cash flows, which is a report reflecting the amount of revenue created and spent during a specified period of time. Here is an example of a statement of cash flows. Investors use this section to understand the health of the company, since a strong cash flow is often needed for growth. It is required by the Securities and Exchange Commission for any company that has their stock on the public market.
Negative cash flow in the red is a sign the business may be failing or just going through a seasonal issue. It is a cause for concern. Positive cash flow in the green is generally a good sign, but it does not guarantee a company is meeting its financial goals.
A cash flow report should include information on at least three different cash flows. Cash flows from operations, this is the money used in buying and selling goods and services. Cash flows from investing, this is money used for buying and selling long-term assets, such as equipment, building, stocks and bonds. And cash flow from financing, this is money involved in borrowing and issuing one's own stock, dividends, and repurchasing shares.
All right, excellent work. In this lesson, we learned about the role of financial planning in an organization. And we reviewed the three different types of financial statements, balance sheets, income statements, and statements of cash flows Thanks for your time, and have a great day.