As a business owner, financial data is critical to your success — but only if you know how to interpret the meaning behind the numbers correctly. Most business owners rely on the aid of an accounting team to accurately analyze and organize financial data, but it’s up to you to make smart decisions based on the information they’ve gathered.
There are three major financial statements your accounting team will present to you on a regular basis: income statements, balance sheets, and statements of cash flow.
With a solid understanding of each financial statement, you can unlock powerful insights to help you compete more effectively in the marketplace, achieve better terms from vendors and suppliers, and offer accurate projections to both internal stakeholders and lending companies alike.
The income statement (also called a profit and loss statement or P&L statement) measures the profitability of your business during a specified accounting period. This statement assesses all of your business’ revenue and expenses, and then reports a net profit or net loss.
By most industry standards, this is the most influential of the three major statements. It breaks down business costs into categories, allowing you to see clearly where your money has been spent — and which of those expenses were directly related to the production of goods and services. It also calculates your company’s earnings from multiple viewpoints; reporting not only the net earnings (your bottom line), but also an assessment of the business’ productive efficiency before the impact of taxes and financing.
It’s helpful to compare multiple income statements from different accounting periods to monitor whether your business is becoming more or less profitable over time — allowing you to adjust your spending and production processes accordingly.
The information on the balance sheet is monumentally more valuable when viewed in conjunction with your income statement. For instance, you can use the data from the balance sheet to determine how many investments are required to support the bottom line shown on your income statement.
While the income statement focuses on one specific accounting period, the balance sheet shows a snapshot of your overall financial health on a specific day by using a simple equation: liabilities + equity = assets.
These factors give you an idea of what the business owns (assets), what it owes (liabilities, including short-term expenses and long-term debt), and how much capital shareholders have invested (equity). As the name suggests, the two sides of the equation in your balance sheet should balance out.
Statement of Cash Flows
The statement of cash flows does just what the name implies — it reports on the flow of cash into and out of your business. Unlike the income statement, which breaks down earnings and expenses into more specific categories, the statement of cash flows is only concerned with the overall amount of money coming in (inflow), compared to the amount of money going out (outflow).
This data is calculated using the following equation: starting cash balance + cash inflows – cash outflows = ending cash balance.
Cash inflows include sales, loans, and accounts receivable collections; while cash outflows include equipment costs, inventory, and expenses paid. The statement of cash flows presents the clearest view of a company’s cash variation — in other words, what caused the balance in your bank account to increase or decrease.