The 3 main financial statements—income statement, balance sheet, and cash flow statement—show how your business is performing and help you make informed decisions about growth, taxes, and investments.
Understanding fundamental accounting terms is crucial for you as a business owner. These terms are the language of business finance and are key tools for communicating your company's financial health to stakeholders, making informed decisions, and ensuring compliance with financial regulations. Your financial statements, which encompass a balance sheet, income statement, and statement of cash flows, are critical for evaluating performance and planning future strategies.
What Are the 5 Basic Financial Statements?
Balance Sheet
Income Statement
Cash Flow Statement
Statement of Retained Earnings
Pro Forma Financial Statements
Each plays a unique role in understanding your business’s financial picture.
Income Statement: Breaking Down Revenue and Expenses
Also known as the Profit and Loss Statement, the income statement shows your business's profitability within a specific accounting period.
Revenue: Money earned from sales and services.
Expenses: Costs incurred to generate revenue.
Gross Profit: Revenue minus the cost of goods sold.
Net Income: What remains after all expenses are deducted.
This statement helps with forecasting and tracking business performance.
Balance Sheet: Understanding Assets, Liabilities & Equity
Your Balance Sheet gives you a snapshot of your company's financial position at a specific point in time. It follows the equation:
Assets = Liabilities + Equity
Assets: Cash, inventory, property
Liabilities: Loans, payables
Equity: Owner's capital, retained earnings
A healthy balance sheet reflects stability and boosts your credibility with lenders and investors.
Cash Flow Statement: What It Tells You About Your Business
The cash flow statement shows how money is flowing in and out of your business.
Operating Activities: Cash from your main business operations
Investing Activities: Equipment purchases, investments
Financing Activities: Loans, shareholder transactions
Maintaining positive cash flow is essential to sustaining daily operations.
What Are Pro Forma Financial Statements?
Pro forma statements are projections of future income, expenses, and cash flow based on assumptions. They’re useful for business planning and pitching to investors.
🔗Read Harvard's guide to pro forma financial statements
Use them to:
Forecast growth
Plan for expansion
Secure funding
Cash vs. Accrual Accounting: Which Do Financial Statements Use?
Your method of accounting affects how your financial statements are prepared:
Cash Basis: Records income and expenses when money changes hands
Accrual Basis: Records income and expenses when they’re earned/incurred
Most businesses eventually switch to accrual for greater accuracy and compliance withIRS guidelines.
How to Read Financial Statements for Your Small Business
Understanding how to read financials empowers smarter decision-making:
Look at net profit on the income statement
Check debt levels and assets on the balance sheet
Watch cash flow trends—are you earning or burning?
Explore accountants for small businesses on Sam’s List
Common Financial Mistakes Business Owners Make
Thinking revenue = profit
Ignoring balance sheet health
Forgetting about upcoming tax liabilities
Not tracking accounts receivable/payable
These lead to cash flow issues and tax season surprises.
Frequently Asked Questions (FAQ)
What are the 3 most important financial statements?
The income statement, balance sheet, and cash flow statement.
What is a 3-statement financial model?
It’s a model that links the income statement, balance sheet, and cash flow to project future performance.
What is the difference between a balance sheet and income statement?
The balance sheet shows assets and liabilities at a point in time. The income statement shows income and expenses over a period.
What are pro forma financial statements used for?
They are used for forecasting and financial planning.
Do I need an accountant to understand my financial statements?
Not always—but a goodaccountant for small businessescan help you interpret the numbers and make smarter moves.
Final Thoughts
Financial statements are more than just reports. They’re roadmaps. Learn to read them, and you’ll be better prepared to lead your business.
🔗Find vetted small business accountants on Sam’s List
Author: Kimi, Co-founder of Sam’s List
Kimi writes about what she’s learning while building Sam’s List and shares honest takeaways from her conversations with accountants and financial advisors across the country. None of this is financial advice—just the stuff most people wish someone told them sooner.
