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How to Read a Financial Statement

Accounting and Bookkeeping Advice
January 17 2020 • Author: Jessie Seaman
Financial statements are essential for running a successful business. They can give you insight on the financial position of your company and help you determine whether your company is in a good state, or may need some help. Imagine trying to bake a gourmet cake without having a recipe. Unless you’re a master chef, this task can be rather tricky. The same goes for financial statements. Without these documents serving as a compass, you may not know what direction to lead your company in, which could put a significant dent in your business’s finances. If you’re looking for an answer on how to read a financial statement, you’re in the right place. Below, we’ll go over what a financial statement is, types of financial statements, and a financial statement example. Or, use the list below to navigate to a section of your choice that may have the answer you’re looking for.

What is a Financial Statement

Knowing the financial position of your company is essential to its success, and this is done by analyzing your financial statements. But what is a financial statement? When it comes to accounting, there are three main financial statements businesses use, including a balance sheet, income statement, and cash flow statement. These statements work together to give you and investors an understanding of the money going in and going out of your front doors. Not only are financial statements necessary for knowing how well, or how poorly, your business is doing, they’re needed if you want to apply for a loan or bring on investors. After all, no one wants to invest in a company that’s already in mounds of debt, ready to file for bankruptcy. Financial statements will serve as proof that your company is flourishing, which will attract potential investors to become shareholders in your business. While learning the basics of these three financial statements won’t make you a trained accountant, they will help you understand the financial position of your company so you can make informed decisions to grow your business. With the help of an accounting service or bookkeeping service, such as Community Tax, you’ll be able to take your business to the next level. Our professional accountants and bookkeepers will work with you to make sense of your financial statements, so you know what steps to take next in order to boost your company.

Types of Financial Statement

There are three different types of financial statements that you need to know about as a business owner or investor. These three financial statements are the balance sheet, income statement, and cash flow statement. Below, we’ll go into detail about each type of statement and why they’re important for your business.

Balance Sheet

The first type of financial statement you should know about is the balance sheet . A balance sheet is an important financial statement that lists your company’s assets (what you own), your liabilities (what you owe), and shareholders’ equity (investors who bought into your company). These three elements can fluctuate each month, which is why it’s important to understand what each is and how they may impact your company’s finances. Examples of assets include:
  • Inventory
  • Cash
  • Stock
  • Treasury bonds
  • Property
  • Intellectual property
  • Copyrights
  • Equipment
Examples of liabilities include:
  • Rent
  • Wages due
  • Taxes due
  • Account payable
  • Long-term debts
  • Loans
Shareholders’ equity is all of the money left over after total liabilities are subtracted from total assets, which include:
  • Retained earnings
  • Value of your company’s stock
  • Amount of money stockholders paid for their shares
These three components of a balance sheet will give you an understanding of your company’s financial position by letting you know your company’s:
  • Liquidity, by determining if your current assets can pay off your current liabilities
  • Efficiency, by comparing your balance sheet and income statement to see if your assets generate revenue
  • Finances, by analyzing whether you’re accumulating debt at a dangerous level

Income Statement

The next type of financial statement is the income statement, or a profit and loss statement. An income statement documents your company’s revenue and expenses during a specific accounting period, such as monthly, quarterly, or annually. Depending on your company’s operations, you get to choose the time period in which you report, and all income statements must be sent to the U.S. Securities and Exchange Commission (SEC). Similar to the balance sheet, the income statement is comprised of various categories. If you want to know how to read a financial statement, such as an income statement, you need to understand what each category is. These include:
  • Operating revenue: Income generated from primary business activities, such as the sale of goods and services
  • Non-operating revenue: Income generated from secondary business activities, such as interest accrued from a bank account or income from royalty payments
  • Gains: Income generated outside of normal business operations, such as the sale of assets like equipment or property
  • Expenses for primary activities: Expenses from primary business operations, such as the cost for inventory to create the products your business sells
  • Expenses for secondary activities: Expenses from secondary business activities, such as interest from a small business loan
  • Losses: typically one-time costs that do not regularly occur, such as payments for a lawsuit

Cash Flow Statement

The third type of financial statement that businesses need to understand their financial position is the cash flow statement. The cash flow statement  reports the inflow and outflow of cash during a specific period, such as monthly, quarterly, or annually. The cash flow statement is also broken up into three separate categories, including:
  • Cash from operating activities, such as receipts from services and sales of goods and salary payments to employees
  • Cash from investing activities, such as cash spent on equipment needed for the company or the property its located on
  • Cash from financing activities, which is usually the company’s debts in the form of equity, such as cash accrued from selling stocks and bonds.

How to Read a Financial Statement

Now that you know the different types of financial statements, you need to know how to read them. Learning how to read a business financial statement isn’t as challenging as it may seem. If you know how to read the directions on the back of your shampoo bottle, you can learn the basics of reading financial statements. You don’t need to be a seasoned accountant, but investing in a small business accounting service can definitely help. Below, we’ll go over how to read each financial statement.

How to Read a Balance Sheet

A balance sheet is divided into two sections, with assets listed on the left or top of the balance sheet, with liabilities and shareholders’ equity listed on the right side or bottom of the balance sheet. The reason a balance sheet is called a balance sheet is because both sides should balance each other out. This means assets must equal liabilities and shareholders’ equity. If both sides don’t add up, you may have an accounting error, which can turn away investors and get you in trouble with the SEC.

How to Read an Income Statement

When reading an income statement, you start from the top and work your way down to the bottom. The top line represents how much money a company sold during a specific accounting period, or their revenue. Then, the company reports the cost of goods sold, which is the amount of money it cost to produce the products or services being sold that generated revenue. After that, the income statement lists all of the company’s expenses, such as advertising costs, wages, and taxes. Once expenses are deducted from revenue, investors will be able to determine a company’s bottom line, or how much money they have left over once all expenses are accounted for. If the bottom line, or net income, is positive, that’s a good sign. It means the company has enough money to pay its employees, rent, and utilities to continue running without having to borrow money.

How to Read a Cash Flow Statement

The cash flow statement acts as a bridge between the balance sheet and income statement and shows the money going in and out of your doors from one accounting period to the next. To read a cash flow statement, all you have to do is look at the net income, or how much in profits were made, as well as cash generated from operating activities, investing activities, and financing activities. Then, all of the business’s expenses are deducted, such as payroll expenses and repairs, from the total cash available. This number will give you your cash position at the end of the month, which will show whether your company was successful at returning value to stockholders or not.

Financial Statement Examples

Now that you know what a financial statement is, how to read one, and the different types that exist, you’ll be able to read, interpret, and analyze your own financial statements. Below, we provide financial statement examples for balance sheets, income statements, and cash flow statements. These financial statement examples are left blank for you to utilize. It’s also important to remember that each company’s operations may vary, which means you may use all of the lines, or may need to add your own.

Balance Sheet Example

In the balance sheet example below, you’ll notice the top section has areas to list current assets and noncurrent assets, followed by liabilities and shareholders’ equity. Just remember, when filling out your own balance sheet, your assets must equal your liabilities and shareholders’ equity.

Income Statement Example

In the income statement example below, you’ll be able to list your revenue and cost of goods sold, followed by all of your business expenses. Depending on your line of business, you may not utilize each expense line, or you may need to create a new one. Then, you’ll be able to calculate your net operating income.

Cash Flow Statement Example

In the cash flow statement example below, you’ll be able to list your cash receipts and cash paid out for each month of the year. This will give you an overview of what you do with the money you generate, and whether you’re making sound financial decisions each month.

Key Takeaways on Reading Financial Statements

While each financial statement serves its own function, they all work in tandem to give you and shareholders an accurate depiction of your company’s financial standing. The balance sheet, income statement, and cash flow statement work together to tell your business’s financial story. Knowing how to read a financial statement is an important business practice, which can help you create a business budget and keep accurate books. At Community Tax, our accounting and bookkeeping professionals are here to make sure you interpret your financial documents accurately. We even offer a small business tax guide, tax preparation services, and more, so you can focus on your business while we take care of the rest.