Basic Financial Statements

The financial performance of a business is reflected in a series of what they call “financial statements.” While every entrepreneur does not need to be a financial expert, we all need to have at least a basic understanding of these statements and how they show us the financial performance of your business.

“While every entrepreneur does not need to be a financial expert, we all need to have at least a basic understanding of these statements and how they show us the financial performance of your business.” 

A complete set of financial statements is used to give an overview of the financial results and condition of a business. These statements are the common language used by everyone to gain an understanding of the financial status of a business. There are four basic financial statements:

• Income Statement. The income statement (also often called the “profit and loss statement” or “P&L”) tells you whether your business is generating a profit during a month, quarter or year. It shows your revenue or sales and subtracts your costs or expenses to determine if you are making a profit (i.e., when your revenue exceed you expenses). Keep in mind that making a profit is different than generating cash, which is reflected in the Statement of Cash Flows described below.
• Statement of Cash Flows. The statement of cash flows (or cash flow statement) shows cash. It details cash inflows (from sales, revenue financing sources) and cash outflows (from expenses and debt repayments) during a month, quarter or year. This works hand in hand with the income statement. While the income statement shows you if you are making a profit, the cash flow statement shows you where the cash is going. This can provide a useful comparison to the income statement, especially when the amount of profit or loss reported does not reflect the cash flows experienced by the business. For example, you may be selling $100,000 of widgets at a cost of $70,000 and making a $30,000 profit, but if you need to reinvest $50,000 to make more widgets, you are actually losing cash even though you are making a profit.
• Balance Sheet.The balance sheet presents the assets, liabilities, and equity of the business as of a date. Unlike an income statement and cash flow statement which show results over a period, the balance sheet measures a period of time —usually the end of a month, quarter or year.
  • Assets. The assets of the business including cash, accounts receivable, inventory, real estate or deposits.
  • Liabilities. What you owe. This includes accounts payable, loans, and other obligations due at some point.
  • Equity. This is the difference between your assets and your liabilities.
• The main insight gained from this statement is whether or not the business has enough assets and capital to address the current and future liabilities of the business. In other words, is the business properly “capitalized” (i.e., has enough capital) to run itself?
• Statement of Retained Earnings. The statement of retained earnings presents changes in equity during the reporting period. The report format varies but can include the sale or repurchase of stock, dividend payments, and changes caused by reported profits or losses. This is the least used of the financial statements and is commonly only included in the audited financial statement package.

These financial statements are those that are used by everyone to look at the financial performance of the business. They are prepared monthly and used both internally and distributed to third parties such as lenders, investors, board members, and banks.

All businesses, no matter their size, should keep accurate accounting records and prepare these financial statements on a monthly basis. Most standard accounting packages can create these statements as long as the daily transactions of the business are entered (such as sales, expenses, loans, etc.). These financial statements are the standard language used by all to think about the financial status of the business, so at the very least, you should know what they mean and what they are used for.