Understanding 3 key financial statements

Financial statements are reports that show you the financial activities and performance of your business. They show you where your money is coming from, where it is going and how much you have at any point in time. Financials are important and informative tools you should use to track and evaluate the financial health and value of your business. There are three key financial statements business owners should know how to read and analyze: the income statement, balance sheet, and cash flow statement.‍

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Income statement

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An income statement, also called a profit and loss statement (or P&L), shows you how much money your company made and spent over a period of time. Your total profit or loss is what you earned (revenue) less what you spent (costs and expenses). If this amount is positive, it’s called your net income. If it’s negative, it's called your net loss.

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What is included in an income statement?

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1. ‍Revenue: Income generated from sales of your products or services.
2. Cost of revenue: Costs directly related to products or services you produced. This includes direct labor, direct materials and other costs directly related to producing your products or services.
3. Gross profit or loss: Profit your business made after subtracting the costs to produce your products or services from revenue.
4. Operating expenses: Ongoing costs that support the operations of your business. This includes indirect costs like sales, administrative expenses and utilities that cannot be directly linked to the production of your products or services.
5. Net income or loss: Profit your business made after subtracting all costs and expenses from revenue.‍

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Balance sheet

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A balance sheet shows you what your company owns (assets) and what it owes (liabilities) at a fixed point in time. The difference between the two represents the net worth or book value (equity) of your business. This report is called a balance sheet because both sides of the equation (assets = liabilities + equity) must balance.

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What is included in a balance sheet?

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1. Assets: Any valuable resources that your company owns. Assets can typically be either sold or used by the company to make products or provide services.
2. Liabilities: Money your company owes to others. This can include obligations like money borrowed from a bank, rent for use of a building, money owed to suppliers, payroll owed to employees or taxes owed to the government.
3. Equity: Also called capital or net worth, is the money that would be left if your business sold all its assets and paid off all its liabilities. The remaining assets or money would belong to you as the owner of the company.

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Cash flow statement

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A cash flow statement uses information from your business’s income statement and balance sheet to show you how much cash has entered and left your business over a period of time. While your income statement tells you whether your business made a profit, your cash flow statement tells you how much cash that profit has generated. Generally, cash flow statements are divided into three sections: operating activities, investing activities and financing activities.

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What is included in a cash flow statement?

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1. Operating activities: Shows your cash flow from adjusted net income or losses. Operating activities are calculated by adjusting net income for any non-cash items and cash that was used or provided by other operating assets and liabilities.
2. Investing activities: Shows your cash flow from all investing in the period. Investing activities include purchases or sales of long-term assets and other investments.
3. Financing activities: Shows your cash flow from all financing in the period. Financing activities includes cash raised by selling shares of your company or cash paid / borrowed from the bank.

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How are financial statements used?

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Although each financial statement is discussed separately above, keep in mind that they are all related. The changes in assets and liabilities on the balance sheet are reflected on the income statement. The cash flow statement keeps you informed on how much cash was generated from assets on your balance sheet and net income from your income statement. No one financial statement will tell the complete story but together these three statements provide a detailed view of your business's financial health.

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Financial statements are a useful tool to help business owners evaluate performance, measure impact, set goals, develop budgets and forecast results.

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1. ‍Evaluate performance: Understand how your business is performing and track the impact your decisions have on your profits.
2. ‍Measure impact: Analyze your business profitability by segment, customer, project or product / service. Financials allow you to review expenses line by line so you can determine whether to cut costs or reallocate spending.
3. ‍Goal setting: Gain clarity that guides your goal setting and decision-making processes. Financials help to provide context for specific benchmarks that you target.
4. ‍Prepare budgets & forecasts: Financials should be referenced when building your budget and when estimating income and expenses on your financial plan.

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Financial statements and analyses for your business

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Appropriate financial statement presentation is key to achieving useful financial reporting and providing accurate information to you as the business owner. We recommend you prepare financial statements for your business at least monthly. If you are seeking clarity on how to prepare and analyze your financial statements, your accounting team at Taxceed is here to support you.

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Taxceed is a CPA firm based in Washington, D.C. Our mission is to help entreprenuers and business owners achieve long-term success. The firm provides online bookkeeping, accounting, tax services and expert financial advice to businesses. Learn how we can help.