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Understanding Your Business Financial Statements

Financial statements (also called financial reports) are formal records of business financial activity. These reports illustrate an overview of a business’ financial condition and changes in financial position over time. Management, investors, and others use these statements to analyze and understand the company’s short- and long-term financial health. There are three basic financial statements that will probably be most important for your business:

1. Balance Sheet (or Statement of Financial Position or Condition)
2. Income Statement (or Profit and Loss Statement—P & L)
3. Statement of Cash Flows

Here is a summary of each type of statement to help you understand the purpose for each one.

• Balance Sheet—The balance sheet reports on the company’s assets, liabilities, and net worth. Assets include items such as cash, short-term investments, receivables, inventory, pre-paid expenses, long-term investments, property, furniture, equipment, and even intangibles like the value of patents and trademarks.  Liabilities are financial obligations resulting from some past transaction. Liabilities may be long- or short-term, such as money owed on a loan or a mortgage. Net worth is also called owner’s equity or book value of a business. To calculate net worth, subtract liabilities from assets. Net worth should be positive in a healthy business, but it may be negative at times when a business is starting up, expanding, or enduring heavy debt.

• Income Statement (P & L)—The income statement presents income (sales, revenues) less expenses (costs) to determine net income (profit or loss). Revenue is sometimes referred to as the “top line” and net income as the “bottom line.” You can use income statements to compare sales revenues and expenses to previous periods. By comparing expense items as percentages of sales, you can calculate a percentage that you can compare to industry averages for your type of business. This comparison gives you an idea of how well your business is performing compared to others in your industry. Lenders will view your income statement in this way.

• Statement of Cash Flows—The cash flow of a business is the amount of cash received and spent during a specified period. Cash flow reports can be used to evaluate the performance of the business, to determine problems with liquidity (the quick availability of cash), or to determine whether sufficient cash will be available to pay expenses when they are due. Your business may be profitable by year-end, but if you do not have the cash on hand to pay your employees, vendors or taxes, you may need supplemental financing.

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