If you operate a business in Canada, financial statements are important. Some types of companies are required to prepare and file financial statements, and banks might require financial statements when they determine whether to extend credit to your company. Preparing and understanding financial statements is important for companies because they can let you know how your business is doing and whether changes are needed. Your financial statements need to be accurate so that you can take appropriate action based on what you learn from them.
Table of Content:
- What do financial statements include?
- Do I need to prepare financial statements?
- How to prepare financial statements?
- How to read financial statements?
- How to interpret financial statements?
- Accurate vs. inaccurate financial statements
What do financial statements include?
Financial statements include several key documents, including the following:
- Balance sheet
- Income statement
- Statement of retained earnings
- Cash flow statement
- Accountant’s report
- Notes to the financial statement
Each of these components provides important information about a company and its financials. Financial statements may be external or internal. External statements are prepared for tax authorities, investors, or important partners that require financial information about the company and might be released annually or quarterly. Publicly traded companies release financial statements quarterly for their shareholders.
Internal financial statements are prepared for use within a company itself. They may be more flexible and contain a greater amount of analysis. Internal financial statements may be created by different divisions within a company or issued on a more frequent basis such as monthly or quarterly. The most critical components of a financial statement are the balance sheet and the income statement.
External financial statements are normally created using an accrual basis. However, Canadian businesses are allowed to choose the accounting method that they use. The accounting method that is used to prepare financial statements should be listed in the notes to the financial statement.
Do I need to prepare financial statements?
If you are a business owner in Canada who files a T2 return, the Canada Revenue Agency requires you to submit a financial statement with your return. If you are a publicly traded corporation, you are also required to file external financial statements for your shareholders quarterly. Charitable organizations are also required to file financial statements.
Financial statements are important even if you are a sole proprietor who is running a small business out of your home. A financial statement can help you to see how your business is doing and identify the steps that you need to take to reduce your losses and to increase your profits.
If your corporation is filing an electronic T2 return, the CRA uses the General Index of Financial Information or GIFI codes to identify different reports that are normally found in your financial statements, including balance sheets, statements of retained earnings, and income statements. You will enter the GIFI code and the corresponding item. If you are filing a paper return and have revenues of less than $1 million, you will complete Form T1178. If your corporation has revenues of $1 million or more, you will need to complete Schedule 100, 101, and 125.
Small businesses that have loans from a bank may also be required by their lenders to submit audited financial statements. Charities are required to attach their financial statements when they file their T3010 returns. Not-for-profit corporations are also required to file financial statements on an annual basis.
How to prepare financial statements
Preparing financial statements is a multi-step process. You will need to start by organizing all of your documents and receipts. Begin by sorting all of your expense receipts and invoices by the month. This task can be much simpler if you store your expense receipts in folders by month in a filing cabinet or online as you receive them. You should similarly sort and store your credit card and bank statements by month and attach corresponding receipts to the statements to make it easier to identify the expenses.
After you have organized your documents, the next step is to prepare your expense sheet. This can be done in a spreadsheet that has your business expenses broken down by category and type. To keep your expense spreadsheet accurate, it is best to update it every month instead of waiting to enter everything as the year’s end draws near.
Your expense sheet should account for special accounts such as any GST payable that you have collected, accounts receivable, accounts receivable, income tax payable, and tax depreciation. After you have completed these steps, you will next need to complete your income statement.
The income statement is the amount of profits that a company has earned during the year. To calculate profits, you will total your sales and subtract your expenses and taxes from the total. After preparing the income statement, you will then need to complete the balance sheet.
This statement is arguably the most difficult report to prepare and includes three parts, including assets, equity, and liabilities. The assets are calculated by totaling the cash balance on the final bank account statement for the year with the accounts receivable and the depreciated value of the capital assets. The assets should equal the sum of the company’s liabilities and equity when they are added together.
The equity of a company can be found by subtracting the dividends paid from the net income. The liabilities can be found by adding the accounts payable with the GST and income taxes that are owed.
How to read financial statements
When you receive your financial statements, you can use them to answer several questions that you might have about how your business is doing. The balance and income statements can tell you whether you are losing money or earning a profit. They can also reveal whether you are carrying too much debt. To see what your business owns, you can check the accounts payable on your balance statement, which is also where you can find what your business is invested in. The equity section on your balance statement will tell you what your company is bringing in, and the revenue section of your income statement can tell you what your business overhead is. You can look at your income statement to see if you are losing money or earning a profit.
How to interpret financial statements
The data in financial statements can be used to interpret the health of a company. You can perform some calculations to see whether a business will be able to continue meeting its obligations over time without having to sell off its inventory, for example. From the income statement, you can look at the gross margin, the operating income, and the operating profit margin to determine the EBIT margin. This tells you the business’s operational efficiency. If the number is low, the business either needs to cut costs or raise revenues.
Financial statements are important for business owners because they can tell them how their businesses are doing. Business owners can use the information contained in their financial statements to make decisions about their companies and actions that they can take to improve their profits.
Accurate vs. inaccurate financial statements
The key to accuracy in financial statements is your company’s bookkeeping practices. Inaccurate financial reports can result from carelessness, data misinterpretation, a lack of information, or employee dishonesty. No matter the cause of an inaccurate statement, it can cause major problems for your business. You need to be aware of the potential issues that can occur and work to ensure that your accounting practices are managed correctly.
Inaccurate financial reporting causes misinformed and poor decision-making. Small businesses that cannot hire full-time accountants may find it difficult to uncover inaccurate financial reports. Owners might accept the reports, which will cause problems with the owners’ ability to track expenses and income. Budgets that are prepared based on inaccurate financial statements will also be inaccurate. Miscalculated profits can cause problems whether they are too low or too high. Inaccurately reported low profits will lead to the business being undervalued. Profits that are reported too high will lead to greater tax liability.
Your business’s stakeholders can also be negatively impacted by inaccurate reports. If your statements are inaccurate, your business’s credibility can be harmed. If your company is a not-for-profit organization, your donations may be negatively impacted. Hiring an independent auditor or accountant can help to ensure that your financial statements are prepared according to generally accepted accounting principles or GAAP to assuage these concerns.
If you discover deficiencies, you need to take immediate steps to correct them. In many cases, small businesses turn to family members or others that do not have accounting experience for bookkeeping. You should instead choose financial professionals who have the proper training and expertise to handle your bookkeeping. If you keep your bookkeeping in-house, you should establish strict procedures and methods for monitoring the work of your bookkeeping staff. You might consider purchasing accounting software and should not hesitate to retain an outside auditor of any concerns that arise about your financial reports’ accuracy.
Take steps to prevent fraud. Rotate bookkeeping tasks to prevent a single employee from having too much power over your company’s financial information. Separate the bookkeeper from the person who writes checks. Have staff members check each other’s work.
Partner with Ensight Cloud CPA for your financial statements
Financial statements are crucial for the success of businesses. When they are accurate, they can tell business owners the types of actions that they should take to maintain the health of their companies. When you partner with our financial professionals and accountants, you can be assured that your financial statements will be accurate. We can also advise you about ways that you can reduce costs to improve your bottom line. Contact us today to schedule a consultation about obtaining help with your financial statements.