Financial Statement Basics
Knowing whether a small business is thriving is more complicated than simply opening the cash register and looking at what’s inside. To get a robust picture of a business’s financial state, you’ll want to start with three common documents: the balance sheet, income statement and cash flow statement. Though some financial information appears on more than one statement, each provides a unique perspective on how the business is doing in that moment and as part of a long-term trend.
The balance sheet displays a business’s assets, liabilities and equity at a specific moment in time. Assets would be anything that a business owns of value, such as money in the bank, inventory, accounts receivable and any prepaid expenses. Liabilities are all loans or obligations that the business has to settle using some of its assets, including outstanding bills and payroll. Equity, sometimes called owners equity or shareholders equity, is simply the interest that remains when you subtract the liabilities from the assets.
“Each statement provides a unique perspective on how the business is doing.”
Why it matters: The balance sheet is most often used as a snapshot of how much money a business has and how much it owes. It can also be used to figure out whether a business can pay a dividend to the owner or shareholders and what its debt-to-capital ratio is.
Also known as a profit and loss statement, the income statement shows you how much a business made in revenue and how much it made in profits over a set period of time, such as a year or a month. It includes revenue and also operating expenses, cost of goods or services sold and income tax expense.
Why it matters: Knowing that you sold $10,000 last month doesn’t tell you much unless you know how much the business spent to generate that revenue. The income statement makes these calculations straightforward.
Cash flow statement
Cash flow statements are generally broken into three parts: operating activities, such as adding back income for non-cash depreciation expenses; investing activities, such as the purchase of new equipment or property; and financing activities, such as selling stocks or borrowing from a small business lender. These three sections together present how cash flowed in and out of the business over a set period of time.
Why it matters: The cash flow statement shows much of the same information from the balance statement and income statement, but it’s reordered here to show whether the business generated cash during a set time period. This is key because a business needs to have enough cash on hand to pay its bills.