There are various financial reports that a company or investor may use when evaluating a business, focusing on certain figures and formulas indicating its financial health. This section will take a closer look at three elements of a financial statement — the balance sheet, the income statement and the cash flow statement.
An income statement shows a company’s revenue and expenses over a set period of time. It can also be referred to as a profit and loss statement, P&L report, revenue statement or earnings statement. It documents the company’s bottom line — how much profit it made or loss it took over that period of time.
The income statement is an important indicator of how a company is performing. They can often be complex documents and vary widely in the types of expenses listed. Here’s an example that illustrates the basic formula:
Note: Gross refers to the total amount and Net refers to the amount left over after deductions.
Income – Expenses = Profit or Loss
The balance sheet looks at a single moment in time, rather than an extended period. It evaluates the company’s assets and liabilities and determines the shareholders’ (or owners’) equity.
Assets are anything that is owned by the company that has value. This can be cash, investments, real estate, equipment or inventory. A company can also have intangible assets such as patents or trademarks.
Liabilities are any amounts the company owes. This can be outstanding loans, accounts payable or a mortgage. Liabilities are crucial for a business to understand and control since this will directly impact the shareholders’ equity.
Shareholders’ equity is the amount of money the owners have in the business. This includes money they invested in the company, as well as earnings from the business.
This formula that explains the relationship between assets, liabilities and shareholders’ equity is:
Assets = Liabilities + Shareholders’ Equity
Assets must equal liabilities plus shareholders’ equity, which will be directly determined by total assets minus total liabilities.
Note: Retained Earnings is the profit of the company that is not distributed and is reinvested back into the business.
Cash Flow Statement
A cash flow statement is used to determine how cash comes in and out of the business and the company’s ability to pay its bills. Even if they are profitable, many start-up companies have a hard time managing cash flow. As a result, they run into problems paying their bills on time. Because of the unpredictable nature of a start-up, it can be difficult to know when bills are going to be due or unexpected investments will arise.