Your financial statements can be a wealth of information that is useful for monitoring the health of your business and for making business decisions. But only if you understand them and know what to look for! Here’s an overview of the different statements, and information about how to use them and recognize problems will be in upcoming posts.

There are 3 main financial statements for a business:

-Profit and Loss

-Balance Sheet

-Statement of Cash Flows

Let’s look at each of these.

The Profit and Loss calculates the net revenue for a specified period of time—typically monthly, quarterly, or annually. It starts with Gross Revenue (usually from sales), subtracts Cost of Goods Sold (the cost to produce the products that were sold) to get to Net Revenue, and then subtracts Operating Expenses, which are the expenses to run the business. That leaves Net Operating Income. There may also be sections for Other Income and Other Expense if there were any transactions that were not directly related to the business operations, and that leaves Net Income.

The Balance Sheet shows the net worth of the business on a specific date. It’s often called a “snapshot” because it captures account balances at a specific point in time, unlike the Profit and Loss, which captures activity for a period of time (more like a video). It starts with Assets (what you own, and that increase your net worth), subtracts Liabilities (what you owe) and comes up with Equity, which reflects net worth. This includes owner investments and draws, and current and retained earnings. The equation is Assets = Liabilities + Equity.

The Statement of Cash Flows is an often misunderstood statement that explains the difference in the cash balances for a specified period of time. But it’s not set up as “Money In, Money Out”. It starts with the Net Income from the Profit and Loss, and then adjusts for changes to cash balances that are in the balance sheet and not the profit and loss. This includes things like changes in Accounts Receivable and Accounts Payable, changes in loan balances, owner investments and draws, capital equipment purchases and a host of other transactions.

Many business owners look at the Profit and Loss and wonder why the net income figure is so different from their actual cash flow. The Statement of Cash Flows explains this in the “Adjustments” sections.

Final note: The financial statements can be run on either the Cash or the Accrual basis. The biggest difference between the two is in the amounts for Accounts Receivable and Accounts Payable. The Cash basis recognizes income and expenses only when they are paid, so unpaid customer invoices and unpaid vendor bills are not on the Profit and Loss on the Cash basis. These amounts are on the statements on the Accrual basis.

Keep watching for more information on how to understand and use financial statements to manage your business–and how to recognize mistakes!