Your business’s financial statements tell you where your money is coming from, where it’s going, how much you have to work with, and how your company manages cash flow. They are helpful for making smart business decisions, and they offer clarity in terms of company performance for managers, employees, investors, and lenders. Below we discuss the basics of the three core reports that form a complete set of financial statements and how they give you a full picture of your company’s financial health.

Balance Sheet

This report is an up-to-date snapshot of your business finances. It discloses your company’s assets and debts at a particular point in time. The balance sheet is generally broken up into three different categories: assets, liabilities, and equity.

• Assets: Anything of value that your company owns. Assets are usually categorized into liquid assets (cash or assets that can be easily converted into cash), non-liquid assets (land, buildings, furniture, and equipment), and intangible assets such as copyrights, patents, trademarks, blueprints, computer software, and franchise agreements.
• Liabilities: Debts that your business owes, including bank loans, credit card debt, mortgages, and accrued expenses such as utilities, taxes, or wages owed to employees.
• Equity: The remaining value of the company after subtracting liabilities from assets. Equity can also be comprised of private or public stock, or a primary investment from the company’s founders.

Note that equity is only the “book value” of your business, not the market value if you were looking to sell the company. A company’s market value is typically greater than the book value based on aspects like annual earnings, market value of the company’s tangible and intangible property, and additional factors.

The formula for grasping how these three categories work together looks like this:

Equity = Assets – Liabilities

In other words, any value (equity) your business actually has amounts to what it owns (assets) minus what is owes (liabilities).

Income Statement

Also referred to as a profit and loss statement, the income statement illustrates how profitable your business was over an accounting period—which could be a month, quarter, or year—by revealing your earnings and your expenses. Investors use the income statement to analyze the profitability and future growth of a company.

These statements are designed to be read top to bottom, with your company’s sales revenue at the top. Commonly, this figure will simply show your total revenue for whatever time period the income statement encompasses. Your cost of goods sold (COGS) will follow on the next line. This includes direct expenses such as raw materials, labor, and shipping costs. From there, you will calculate gross profit by subtracting total COGS from revenue. Finally, additional line items of general operating expenses—like marketing and advertising expenses, bank fees, and taxes—will affect your gross profit until you reach your net income, i.e., your “bottom line”.

Cash Flow Statement

The cash flow statement demonstrates how much cash entered and exited your business over a specific time period. Typically, only companies that use the accrual accounting method prepare a cash flow statement. This is because, when using the accrual method, a company’s income statement might include earnings that the company is owed but has yet to receive, and debts the company has incurred but not yet repaid. The cash flow statement shows your liquidity; your changes in assets, liabilities, and equity; and it helps to forecast future cash surpluses and shortages.