Why Do Small Businesses Need Financial Statements?

"Why do we need financial statements for our small business?" you might ask when you really mean "why does our small business need your accounting services?"

“Why do we need financial statements?” is one of the most common inquiries an accountant ever hears from small business owners. It’s a question that might seem straightforward, but often elicits a simplified response from many accountants, who might take giving the answer to this question for granted due to years of expertise and familiarity.

We believe you deserve a comprehensive answer, so here it is.

1) Your Business Financial Statements Are Scorecards

a. Historical Perspective and Performance Evaluation

Financial statements serve as a scorecard against which a company is evaluated. They offer insights into the historical performance of your business, allowing you to compare different time periods and identify growth patterns or areas of concern.

b. Communicating with Stakeholders

Since Venetian merchants pioneered double-entry accounting in the 15th century, financial statements have been used to communicate a company’s past, present, and future prospects to stakeholders. Investors, potential investors, lenders, and even potential employees utilize them to assess various aspects of your business.

Investors and Potential Investors: They evaluate management’s stewardship of the firm, its viability, and as a starting point for estimating future performance.
Lenders and Potential Lenders: They assess a company’s ability to repay debt, which is crucial in loan approval processes.
Potential Hires: If they can view them, financial statements may be used to evaluate if working for your business will be a good idea in the long term.

2) Expected Financial Statements

a. Requirement by Lenders and Investors

Because financial statements bridge the information gap, they are often required by external parties. Many lenders will not even evaluate a loan application if the financials are not up-to-date.

Bankers’ Expectations: They are infamous for being unsympathetic to the pressures entrepreneurs face. Access to capital may hinge on the immediate availability of your financial statements.
Venture Capital Funding: Expansion through venture capital requires financial statements, often several years’ worth, to secure funding.

b. Strategic Planning and Business Expansion

Proper financial reporting also aids in strategic planning. By having a clear picture of your financial situation, you can make informed decisions about expanding or altering your business operations.

3) Regulatory Compliance – The CRA requires financial statements

a. Corporate Tax Filing

In Canada, firms must prepare financial statements to file corporate tax. Penalties for late filing can be substantial, and interest on taxes owed begins to accrue if the T2 corporate tax return is not filed within the stipulated time frame.

b. Compliance and Accountability

Maintaining financial statements helps in ensuring that your business complies with various regulations, standards, and laws. This builds trust with various stakeholders including the government, suppliers, customers, and employees.

The Sooner You Start, the Better

a. Outsourcing as a Priority

While business owners often take on multiple roles in the early stages, financial statement preparation is best outsourced. Working with an accountant ensures proper financial recording, compliance, and access to professional insights.

b. Financing and Tax Advantages

Having financial statements from year one allows for potential financing opportunities and tax advantages. Lenders often require detailed financial history, and filing taxes as a business can offer significant benefits.

What is a Small Business Financial Statement Anyway?

Good question! Essentially, a financial statement provides a detailed snapshot of the financial health of your business. It is typically composed of three key components: the Income Statement, which shows your revenue, expenses, and profits or losses over a specific period; the Balance Sheet, which outlines your assets, liabilities, and owner’s equity at a specific point in time; and the Cash Flow Statement, which traces the flow of cash in and out of your business, highlighting how your business is generating and spending cash. Together, these elements offer a comprehensive view of your financial operations, enabling you to make informed decisions, satisfy regulatory requirements, and communicate transparently with stakeholders. Understanding these statements is not just an accounting formality; it’s a strategic tool that can drive your business forward.

Conclusion

The importance of financial statements transcends mere performance measurement; they are vital for strategic planning, stakeholder communication, compliance, and growth opportunities. Working with an accountant is more than just about numbers; it’s about building a robust foundation for your business’s future.

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