How to Prepare Monthly Financial Statements

Monthly financial statements offer insights into a business’s financial health and performance. These reports provide timely insights, useful for monitoring progress and making informed decisions. Businesses use them to track income and expenses, enabling better financial planning and management.

Understanding Essential Components

Financial statements are built upon fundamental accounting concepts. Assets are resources controlled by the entity from which future economic benefits are expected to flow. Liabilities represent present obligations requiring an outflow of resources. Equity is the residual interest in the assets after deducting all liabilities.

Revenue is income generated from normal business operations, typically from the sale of goods or services. Expenses are costs incurred in generating that revenue. These elements collectively form the basis for the three primary financial statements: the Income Statement, the Balance Sheet, and the Cash Flow Statement.

The Income Statement, also known as the Profit and Loss (P&L) statement, displays a company’s financial performance over a period, detailing revenues and expenses to show net income or loss. The Balance Sheet provides a snapshot of a company’s financial position at a specific point in time, outlining its assets, liabilities, and equity. The Cash Flow Statement tracks the actual movement of cash, categorizing inflows and outflows from operating, investing, and financing activities, which provides insight into liquidity.

Gathering and Organizing Financial Data

Preparing accurate financial statements begins with gathering and organizing financial data. Various source documents serve as initial proof that a financial transaction occurred. These documents include:
Bank statements
Credit card statements
Sales invoices issued to customers
Purchase invoices received from suppliers
Receipts for expenses
Payroll records
Loan agreements

These original records provide essential details such as the date, amount, description, and authorization for each transaction. Once collected, this raw data needs to be systematically categorized. A Chart of Accounts is a structured list of all the accounts used by a business, providing a framework for organizing transactions.

Common account categories often include “Cash” for bank balances, “Accounts Receivable” for money owed by customers, “Sales Revenue” for income from goods or services, and “Rent Expense” for payments made for leased property. Transactions are then recorded into ledgers, either manually or using accounting software, which helps to input and process the data efficiently. This organized system ensures that all financial activities are captured accurately before any calculations or adjustments are made.

Making Adjusting Entries

After initial data collection, adjusting entries are necessary to refine financial information and ensure accuracy under the accrual basis of accounting. This approach recognizes revenues when earned and expenses when incurred, regardless of when cash changes hands. Adjusting entries are made at the end of an accounting period to align financial records with the correct period, preventing misstatements of income, expenses, assets, and liabilities.

One common type is an accrual, which accounts for revenues earned but not yet recorded, such as interest earned or services rendered but not yet billed. Conversely, accrued expenses are costs incurred but not yet paid, like salaries owed to employees at month-end. Deferrals relate to cash received or paid in advance of the service or benefit being provided. Prepaid expenses, such as rent or insurance paid for several months in advance, are initially recorded as assets and then expensed over time as the benefit is consumed.

Deferred revenue, also known as unearned revenue, occurs when a business receives payment for goods or services before they are delivered, recorded as a liability until the revenue is earned. Depreciation is another adjusting entry, allocating the cost of long-term assets, such as equipment or buildings, over their useful life. This non-cash expense reflects the asset’s gradual wear and tear or obsolescence. Additionally, an estimate for uncollectible accounts receivable, known as bad debts, might require an adjusting entry to accurately reflect the value of expected collections.

Generating the Core Financial Statements

With the financial data gathered, organized, and adjusted, the core financial statements are constructed. The Income Statement is prepared first, summarizing revenues and expenses for the period to determine net income or loss. All recognized revenues are totaled, and then all incurred expenses are subtracted, including non-cash expenses like depreciation, to arrive at the bottom-line profit or loss.

Following this, the Balance Sheet is created, presenting a company’s financial position at a specific point in time. This statement adheres to the fundamental accounting equation: Assets = Liabilities + Equity. All assets, such as cash, accounts receivable, and property, are listed, and their total must equal the sum of all liabilities, like accounts payable and loans, plus the owner’s equity. The Cash Flow Statement then details the movement of cash over the period, divided into three sections.

Operating activities include cash flows directly from normal business operations, reflecting how much cash the business generates from its core activities. Investing activities show cash used for or generated from the purchase or sale of long-term assets, such as property or equipment. Financing activities involve cash flows from debt and equity transactions, including borrowing money, repaying loans, or issuing dividends. This statement reconciles the beginning and ending cash balances, providing a comprehensive view of cash inflows and outflows.

Interpreting the Statements

Interpreting financial statements provides essential insights for understanding a business’s performance and making informed decisions. The net income figure on the Income Statement indicates profitability over a period, revealing whether a business is earning more than it spends. On the Balance Sheet, total assets represent the resources controlled by the business, while the relationship between assets, liabilities, and equity offers a view of financial stability and structure.

The Cash Flow Statement’s operating activities section shows the cash generated from core business functions, which is a key indicator of a business’s ability to sustain itself and meet obligations. Analyzing these statements together can identify trends over time, such as increasing revenue or improving cash flow. This allows for assessing liquidity, the ability to meet short-term obligations, and solvency, the ability to meet long-term debts. Such analysis empowers owners and managers to pinpoint areas for improvement, evaluate investment opportunities, and develop strategic plans.