This article contains general information and is not intended to provide information that is specific to American Express, or its products and services. Similar products and services offered by different companies will have different features and you should always read about product details before acquiring any financial product.
Business owners and managers may want to understand financial statements even if they don’t have a finance background. Financial statements are formal documents that chart a company’s financial performance and activities.
Understanding how to compile and read these statements could help you improve money management and gauge financial health. These documents may provide valuable insight into business profitability, liquidity, and financial stability for investors and stakeholders.
This guide explains three types of financial statements, including examples, as well as how to read financial statements to help evaluate financial health and inform business decisions.
Key takeaways:
- Financial statements are formal documents that summarize a company's financial performance and activities.
- Types of financial statements may include income statements, balance sheets, and cash-flow statements.
- Business owners may use financial statements to evaluate a company’s profitability, liquidity, and financial stability, potentially helping to guide key decisions for long-term growth.
Why Financial Statements May Matter for Business Owners
Financial statements may help non-finance professionals, like business owners without a background in money management, evaluate the health of their business. They may provide a clearer picture of how much money the company is spending and earning and how to prepare for growth.
Business financial statements may help support strategic decisions, such as:
- Budget optimization: Are there areas to cut back on spending to help manage cash flow and profit?
- Growth planning: What level of funds is needed to scale, such as by hiring more staff or acquiring office or retail space?
- Investment opportunities: What cash is available for potential business investments?
- Funding: Are you closely tracking financial performance to show profitability for potential investors?
Types of Financial Statements
There are three primary financial statements that business owners may use to help evaluate financial performance. Each has its own use cases, data, and calculations to help understand a company's financial health.
1. Income Statement
An income statement summarizes revenue, expenses, and profits over a specific period of time, such as a quarter or year. This document may help to show whether a company is making money from its operations, and may be used in business accounting.
Income statements could include:
- Revenue: Income generated from all sales
- Cost of goods sold: Total cost of producing or acquiring the products
- Gross profit: Revenue minus the cost of goods sold
- Operating expenses: Total costs of running the company, such as salaries and rent
- Net income: Revenue minus all expenses and cost of goods sold
If the net income is negative, the business operated at a loss during this specific period. If the number is positive, the business earned a profit.
Income Statement Example
Consider this income statement example for a business over a one-year period:
- Revenue = $100,000
- Cost of goods sold = $25,000
- Gross profit = $75,000
- Operating expenses = $50,000
- Net income = $100,000 - $25,000 - $50,000 = $25,000
The business made a total profit of $25,000 over a one-year period.
2. Balance Sheet
A balance sheet may provide a snapshot of a company’s financial position at a specific moment. This document could include:
- Assets: Things the business owns, such as cash, inventory, and equipment
- Liabilities: Amounts the business owes, such as mortgages, payroll, and loans
- Shareholder equity: The company’s net worth, calculated as assets minus liabilities
By calculating your equity, you may see how much money would be left over if the business shut down and paid off its debts. Business owners may use this information to evaluate financial risk and show their financial standing to investors or lenders.
Balance Sheet Example
Let's look at a balance sheet example:
Assets
- Trucks = $150,000
- Supplies = $50,000
- Construction equipment = $200,000
- Office space = $400,000
- Total Assets = $800,000
Liabilities
- Credit card debt = $30,000
- Unpaid vendor invoices = $50,000
- Truck and equipment loans = $230,000
- Mortgage on office space = $350,000
- Total Liabilities = $660,000
Shareholder equity = $800,000 - $660,000 = $140,000
3. Cash-Flow Statement
A cash-flow statement tracks the inflow and outflow of cash and may help businesses understand whether they have enough liquidity to cover operating expenses.
Cash-flow statements may cover:
- Cash flow from operations
- Operating cash inflow: Money earned from customer payments and interest income
- Operating cash outflow: Money spent on operational needs, such as salaries and utilities
- Cash flow from investments:
- Investment cash inflow: Money earned from selling long-term business assets, like equipment or real estate
- Investment cash outflow: Money spent on assets, like buildings and vehicles
- Cash flow from financing
- Financing cash inflow: Money earned from loans, capital contributions, and issuing stocks
- Financing cash outflow: Money spent on loan payments, stocks, and cash dividends
- Net cash flow: Total cash inflows minus total cash outflows
This statement may also show which business activities generate cash and which are responsible for the highest expenses. It could also show whether the business has enough money on-hand to continue operating in the short and long term.
Cash Flow Statement Example
Consider this cash-flow statement example for guidance:
- Cash flow from operations
- Operating cash inflow = $75,000
- Operating cash outflow = $50,000
- Cash flow from investments
- Investment cash inflow = $0
- Investment cash outflow = $10,000
- Cash flow from financing
- Financing cash inflow = $0
- Financing cash outflow = $20,000
Net cash flow = -$5,000
How to Read Financial Statements
Interpreting financial statements may go beyond just reviewing numbers and checking balances. There are key takeaways business owners may look for between the spreadsheet columns and rows.
You may evaluate your financial statements to:
- Determine profitability: Consider using your income statement to help determine your net income and see if you turned a profit. Compare income statements over time to see when costs have been particularly high or low, and consider adjusting spending accordingly.
- Calculate liquidity: Liquidity refers to a business’s ability to access enough cash to cover its short-term expenses, potentially within a year. Consider using your balance sheet and cash-flow statement to compare the value of your liquid assets to your liabilities to help determine liquidity.
- Identify financial trends: Evaluate statements from different time periods to help identify patterns in cash flow, spending, and profits. These trends may be used to help forecast financial performance and help prepare for predictable fluctuations, such as during seasonal spikes or lulls.
How Businesses Could Use Financial Statements for Decision-Making
Financial statements may be valuable resources for business owners and managers. You don't need to be a CFO or have a finance background to use them, either. By understanding the basics of income statements, balance sheets, and cash-flow statements, business owners may be able to make more informed financial decisions and manage profitability with long-term growth in mind.
Photo: Getty Images
The material made available for you on this website is for informational purposes only and is not intended to provide legal, tax or financial advice. If you have questions, please consult your own professional legal, tax and financial advisors.
