Financial statements are powerful tools that tell the story of your business. Understanding these documents helps you make better decisions, identify problems early, and communicate effectively with lenders and investors.
The income statement, also called a profit and loss statement, shows your revenue and expenses over a specific period. It answers the fundamental question: did you make money or lose money? Look at both the total profit and the profit margin to understand your profitability.
Revenue appears at the top of your income statement, showing all income from sales or services. Below that, you will see cost of goods sold, which includes direct costs to produce your products or deliver your services. The difference is your gross profit.
Operating expenses include all costs of running your business that are not directly tied to production, such as rent, utilities, salaries, marketing, and insurance. Subtracting operating expenses from gross profit gives you operating income or EBITDA.
The balance sheet provides a snapshot of your business financial position at a specific point in time. It shows what you own (assets), what you owe (liabilities), and the difference (equity). The balance sheet must always balance: Assets = Liabilities + Equity.
Current assets include cash and items that will convert to cash within a year, like accounts receivable and inventory. Fixed assets are long-term items like equipment and property. Understanding your asset composition helps you manage working capital.
Liabilities are divided into current (due within a year) and long-term (due after a year). Common liabilities include accounts payable, loans, and credit cards. The ratio of current assets to current liabilities indicates your ability to pay short-term obligations.
The cash flow statement tracks how cash moves in and out of your business. Unlike the income statement, which uses accrual accounting, the cash flow statement shows actual cash movements. You can be profitable on paper but still run out of cash if you do not manage cash flow properly.
Review your financial statements regularly and compare them to previous periods. Look for trends, unusual changes, and areas for improvement. Financial statements are most valuable when you use them actively to guide your business decisions.