The Three Financial Statements
There are three financial statements every business owner should be able to read:
- Balance sheet — shows assets, liabilities, and equity at a point in time.
- Income statement — shows income, expenses, and profit over a period.
- Cash flow statement — shows how cash moved in and out over a period.
Balance Sheet
The balance sheet is a snapshot. It answers: what does the business own, what does it owe, and what is left for the owner? It is the accounting equation in report form.
Income Statement
The income statement covers a period — a month, a quarter, a year. It starts with income, subtracts the cost of goods sold to reach gross profit, then subtracts operating expenses to reach net profit.
Cash Flow Statement
The cash flow statement reconciles the profit shown in the income statement to the actual cash movement shown in the bank. It groups cash flows into operating, investing, and financing activities.
Key Relationships
- Net profit from the income statement flows into retained earnings in the balance sheet.
- Cash on the balance sheet should reconcile to the closing balance in the cash flow statement.
- If profit is rising but cash is falling, the business may have a collection problem.
Red Flags
- Profit without cash — customers are not paying.
- Growing inventory faster than sales — cash is tied up in stock.
- Rising debt with falling profit — the business is borrowing to cover losses.