Understanding the 3 Key Financial Statements in Bookkeeping
As a business owner, having a clear grasp of your businesses’ financial health is essential.
But how do you get that data? For most businesses everything you need to know about the financial health of your business comes from preparing and reviewing three essential financial statements: the Balance Sheet, the Income Statement (or Profit and Loss Statement), and the Cash Flow Statement.
While these might sound a little intimidating, I’ll walk you through them so you can understand what they mean and why they matter to your business.
- Balance Sheet
The Balance Sheet is like a snapshot of your business’s financial position at a specific point in time. It shows what your business owns (Assets), what it owes (Liabilities), and what’s left over for you as the owner (Equity).
- Assets include everything your business owns, like cash in the bank, equipment, inventory, and any outstanding amounts owed to you by customers (accounts receivable).
- Liabilities are the debts your business owes to others, such as loans, unpaid bills, or taxes due.
- Equity is essentially what’s left over after liabilities are subtracted from assets—this is your ownership in the business.
The formula for the Balance Sheet is: Assets = Liabilities + Equity.
This document gives you a clear picture of whether your business is financially sound. If your assets exceed your liabilities, you have a positive net worth; if it’s the other way around, your business could be in trouble.
- Income Statement (Profit & Loss)
The Income Statement, often called the Profit and Loss Statement (P&L), tells the story of your business’s performance over a period of time—whether it’s a month, a quarter, or a year. It shows how much money you’re bringing in (Revenue), what it costs to run your business (Expenses), and what’s left after covering those costs (Profit or Loss).
- Revenue is the total income from sales or services.
- Expenses include everything from rent to wages, utilities, supplies, and any other costs your business incurs.
- Profit (or Loss) is the result. If your revenue is greater than your expenses, you’ve made a profit. If not, you’ve incurred a loss.
The Income Statement is essential because it helps you understand whether your business is generating a profit, which directly affects how you plan for future growth or adjust your strategy.
- Cash Flow Statement
The Cash Flow Statement shows how cash moves in and out of your business over a period of time. It’s crucial because even if your business is profitable on paper (according to the Income Statement), you might still run into trouble if cash isn’t available when you need it.
There are three main sections to the Cash Flow Statement:
- Operating Activities: Cash generated from the day-to-day running of your business, like sales to customers.
- Investing Activities: Cash used for or earned from investments, such as buying or selling equipment.
- Financing Activities: Cash raised through loans or investor funding and any repayments made.
The Cash Flow Statement is key to managing your business’s liquidity. It helps you make sure that your business has enough cash on hand to cover immediate expenses, like paying suppliers or salaries.
Bringing It All Together
These three financial statements give you different perspectives on your business’s health.
- The Balance Sheet shows the overall financial position,
- The Income Statement tells you if you’re making money, and
- The Cash Flow Statement ensures that you can keep operating smoothly.
At Business Angels, we specialize in helping business owners not just understand these reports but also use them to make informed decisions. Whether you’re looking to grow, reduce costs, or prepare for tax time, understanding these financial statements is the first step to staying on top of your business’s finances.