Small Business Financial

Fundamentals Guide:

Financial
Statements 101
The Income Statement
The Income Statement is also called a Profit & Loss Statement. If you are wondering
about the profitability of your company or “the bottom line” then look no further than the
bottom line of your Income Statement.

This standard form shows sales first, then the cost of sales (or cost of goods or cost of
goods sold (COGS), or direct costs, all of which are the same thing). Then it subtracts
costs from sales to calculate gross margin, which is defined as sales less the cost of
sales. Then it shows operating expenses, usually (but not always) subtracting operating
expenses from gross margin to show EBIT (Earnings Before Interest and Taxes). Then it
subtracts interest and taxes to show profit.

Sales - Cost of Sales = Gross Margin

Gross Margin - Expenses = Earnings Before Interest and Taxes

EBIT - Interest and Taxes = Net Profit

The Income Statement is about the flow of transactions over a designated period—such
as a month, a quarter, a year, or several years.

Download our sample Income Statement.

The Balance Sheet

A Balance Sheet is straightforward. It shows your company’s assets, liabilities, and

owner’s equity at a specific point in time. Put simply, a Balance Sheet shows what
a company owns (assets), what it owes (liabilities), and how much owners and
shareholders have invested (equity/capital). Think of this document as a snapshot of
your company frozen in time. The details of your Balance Sheet will be different each
time you take a new snapshot. It will always show assets on the left side or on the top,
with liabilities and equity (capital) on the right side or the bottom.

Balance Sheets must always obey the following formula:

Assets = Liabilities + Equity

Unless this simple equation is true, the Balance Sheet doesn’t balance, and the numbers
are not right. You can use that to help make estimated guesses and pull things together
for projected Cash Flow.

Download our sample Balance Sheet.

Financial Statements 101

The Cash Flow Statement

The Cash Flow Statement is one of the three main financial statements (along with the
Income Statement and Balance Sheet) that shows the financial position and health of a
business.

It shows the actual cash inflows and outflows. The statement then compares cash received
to cash spent to determine if a business is cash flow negative or cash flow positive. The
Cash Flow Statement also shows how much cash a business has on hand at the end of the
specified period.

A cash flow positive business is receiving more cash than it is spending. Likewise, a cash
flow negative business is spending more cash than it is receiving.

Download our Cash Flow Template to help you get started.

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Financial
Financial Statements
Statements 101
The Two Types of Cash Flow Statements
There are two different types of Cash Flow Statements that a business may produce:
An Indirect Cash Flow Statement and a Direct Cash Flow Statement.

Indirect Cash Flow Statement

The indirect method starts with Net

Income from the Income Statement
and then makes additions and
subtractions from that number to
arrive at cash flow.
The Indirect Cash Flow Statement is
more popular because it can be easily
created from reports produced by
accounting software. That said, it can
be more difficult to use for cash flow
forecasting.

Direct Cash Flow Statement

The direct method simply totals up

cash received, and cash spent, and
then compares the two numbers to
arrive at a cash flow number.

Learn more about Cash Flow from

Investopedia.

How to Use a Cash Flow Statement

The Cash Flow Statement shows if a business is bringing in cash or losing cash over time.
With cash being the lifeblood of business, knowing if cash is moving into the business or
out of the business is critical.

You can use the Cash Flow Statement to calculate cash runway - the amount of time that a
business can stay in operation if it continues to lose money at its current pace. Cash Flow
Statements are an important part of a business plan as lenders will look for positive cash
flow as part of their overall lending criteria.

Financial Statements 101

How Cash Flow Statements work with your Income Statement &
Balance Sheets
Along with the Income Statement and Balance Sheet, the Cash Flow Statement is one of
the three critical financial statements you can use to evaluate a business’s performance.
It is also the most important, and least intuitive, of the three. In both mathematical and
financial detail, it reconciles the Income Statement with the Balance Sheet - but that
detail can be hard to see and follow. What is most important is tracking the money. By
cash we mean liquidity, as in the balance in chequing and related savings accounts, not
strictly bills and coins. Tracking cash is the most important thing a Cash Flow Statement
does. The underlying truth is:

Ending Cash = Starting Cash + Money Received - Money Spent

What’s particularly important in planning is that neither the Income Statement nor the
Balance Sheet alone is enough to plan and manage cash.

The Income Statement records booked sales and expenses and calculates profits. It is
important to know if a business is profitable or not, but you then turn to the Cash Flow
Statement to see how this activity impacts cash.

The Income Statement does not reflect cash received and spent. This is because
customers often take time to pay after they receive an invoice and businesses also don’t
pay all their bills right away.

The Balance Sheet connects to the Cash Flow Statement in that it also records the
amount of cash a business has on hand. In addition to this key metric, the Balance Sheet
also lists a business’s assets and its liabilities.

Financial
Financial Statements
Statements 101