What are business financial statements and what are they for?

As your business grows, so does the amount of financial data you regularly need to sift through — such as cash flows, income, and expenses. If you’re new to financial statements, think of them as reports that provide all the critical information you need to determine the health of a business.

Balance sheet

A balance sheet gives you a snapshot of your financial position at a specific moment in time. The top of the balance sheet always shows your assets, while the bottom shows liabilities and equity.

Here's what each section includes.

Assets

Assets in balance sheet statements are everything you own that provides value to the company. Examples of assets include:

• Cash: Money that you have in accounts and liquid assets that can be easily converted into cash
• Investments: The value of stocks, bonds, and other securities owned by the company
• Accounts receivable: Money that is owed to you for goods or services you've sold but has not yet been paid for
• Inventory: The value of products and goods on hand
• Prepaid expenses: Things that have already been paid for, such as a lease or insurance premium
• Property: The land and buildings owned by the business
• Equipment: The machinery, hardware, and furniture used by the business
• Intangible assets: Items like patents and trademarks that aren't physical but have value

Liabilities

Liabilities in balance sheet statements tell you all the financial obligations your company has to vendors, lenders, employees, and others. Examples of liabilities include:

• Accounts payable: Money owed to vendors for goods or services you've received but have not yet paid for
• Wages payable: Payroll that you owe employees for work they've completed but have not yet been paid for
• Notes payable: Debt and interest from bank loans that the company still owes
• Dividends: The distribution of profits owed to shareholders
• Long-term debt: Any debt not due within the next 12 months, such as a mortgage

Shareholder equity

Shareholder equity is the assets owned by the business' shareholders. Examples include:

• Total assets minus total liabilities: The company’s value that is attributable to the owner
• Retained earnings: Profits that are retained by the business instead of being distributed as dividends

Balance sheet example

A balance sheet begins with the company's assets, which are divided into current assets and long-term assets. The liabilities are then listed, including current liabilities and long-term liabilities. Finally, the equity section shows the company's common stock and retained earnings, which represent the profits that have been retained in the business rather than distributed to shareholders as dividends.

Income statement

What is an income statement? It's a document that shows a company's profit and losses over time. When looking at an income statement vs. balance sheet, it's important to understand the differences, so you use the right one at the right time.

Let's look at what makes up an income statement.

Revenue

Revenue shows you the money that is coming into your business. There are two types of revenue:

• Operating revenue: Money generated from your main business activities, such as sales
• Non-operating revenue: Money generated from other sources, such as investments or bank account interest

Some businesses generate significant revenue from both sources. For example, if you own your building, you may generate operating revenue from your sales activities in addition to non-operating revenue from leasing out extra space to others for storage.

Expenses

Expenses show you the money you are spending to run your business. This includes the money you spend to pay for products and materials, employee wages, sales commissions, utilities, rent, and taxes.

Income statement example

An income statement begins with the company's revenue, which includes sales revenue and other revenue. The expenses are then listed, including the cost of goods sold, wages and salaries, rent, utilities, insurance, depreciation, and other expenses. The net income before taxes is calculated as the revenue minus the expenses. Income taxes are then subtracted, resulting in a net income after taxes.

Cash flow statement

What is a cash flow statement? The purpose of a cash flow statement is to help you see the movement of cash throughout your business as it comes in and out of your business over a period of time. This can help you ensure you don't get stuck without funds at the wrong time. Check out these tips for getting out of a cash flow crunch.

Here's what to look for in a cash flow statement.

Operating activities

Operating activities in a cash flow statement show the revenue-generating activities of your business, such as sales. They also show the activities that impact revenue, such as wages, taxes, and rent payments.

Investing activities

Investing activities show the cash used and generated by the purchase and sale of investments, such as property, equipment, and securities.

Financing activities

Financing activities show the cash used to finance operations and growth through the use of debt issuance, equity issuance, stock repurchases, loans, dividends, and debt repayments.

Cash flow statement example

A cash flow statement is typically divided into three main sections: operating activities, investing activities, and financing activities. It ends with the net increase in cash and cash equivalents for the year, as well as the cash and cash equivalents at the beginning and end of the year.

How are the three financial statements linked?

When reviewed in combination, these three key statements can give you a comprehensive view of the health of your business. The balance sheet reflects your financial position, the income statement helps you quantify your profitability, and the cash flow statement shows how cash enters and exits the balance sheet. Here's how they compare.

• Income statement vs. balance sheet: An income statement shows revenue over time, while the balance sheet is a snapshot of your overall financial strength at the moment.
• Cash flow statement vs. balance sheet: A cash flow statement helps you identify if you might have a crash crunch, while the balance sheet shows the overall positioning of the business.
• Income statement vs. cash flow statement: An income statement shows overall revenue and expenses, while the cash flow statement shows when and how cash enters and exits the business in the form of revenue and expenses.

Limitations of financial statements

While financial statements are a powerful tool, keep in mind that they only provide a snapshot of your business over a specific period of time. In addition, they can't show non-financial factors that may impact your business, such as your marketing and sales strategies, the actions of competitors, or changes in consumer preferences.

What is GAAP?

GAAP stands for Generally Accepted Accounting Principles. According to the U.S. Department of Justice, GAAP is a common set of accounting rules, requirements, and practices as defined by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB).

By providing an accounting standard, GAAP ensures that financial statements are clear, consistent, and easy to compare over time and across different businesses.

What financial statements are required by GAAP?

The financial statements required by GAAP are the balance sheet, income statement, and cash flow statement. Keep in mind that GAAP only applies to publicly traded companies, so small businesses don't necessarily need to worry about GAAP standards.

Are financial statements public?

Financial statements are only public if your business is a publicly listed company. If your business is privately owned, then you are not obligated to publicize your financial statements.

Understanding the financial state of your business

Financial statements help you determine the financial state of your business, so you can make the right decisions about how to adjust operations, attract investors, or apply for financing. Discover more accounting tips for your business.