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How to read a financial statement

It's often the last thing you want to face. However, being able to get your head around a balance sheet could put your business in a much stronger position.

The importance of understanding financial statements

The main purpose of knowing how to read a financial statement is to give you a clear picture of your company’s financial performance. It can also help you when it comes to decision-making.

Doing so will provide you with an overview of your company’s financial health, profitability, and potential for growth.

The main components of financial statements are:

  • Revenue – how much your business is making
  • Expenses – how much it’s costing you to generate that revenue
  • Net profit – what you’re left with after deducting expenses from your revenue
  • Debts – what liabilities your business has
  • Cash flow – how well your business manages money coming in and money going out
  • Assets – what they are and what their value is

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3 different types of financial statements

What is a financial statement? You might be wondering. There are three financial statements you should understand as a business owner.

The balance sheet

What is a balance sheet?

A balance sheet provides a snapshot of what your business owns (assets) and owes (liabilities), as well as shareholder equity at a fixed point in time. It’s key to accounting and helps you quickly understand how much your business is worth. It’s crucial to ensure your books balance and can help with lending opportunities.

The profit and loss statement

What is a profit and loss statement?

Also known as an ‘income statement’, a profit and loss statement outlines what your business made (revenue), costs and expenses. It helps to track business performance against projections, indicating a profit, loss or break even. If problems are identified, timely corrections can be made.  

The cash flow statement

What is a cash flow statement?

A cash flow statement is the money coming into your business versus the amount going out. It projects this from the current year to five years, illustrating how you’ll run in the short and long-term. It’s useful for predicting future income, as well as identifying ways to improve profitability.

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How to read a balance sheet

Your balance sheet includes:

  • Your business assets
  • Your business liabilities
  • Your equity

It shows the number and value of your company assets, the debts owed, and equity at the end of a reporting period.

How to read financial statements

Understanding your balance sheet

Assets

These are the things your company owns that have value, for example:

  • Tools
  • Equipment
  • Materials
  • Plant
  • Machinery
  • Vehicles
  • Cash and investments are also assets

Assets are typically listed on the left-hand side or at the top of a balance sheet, depending on how it’s laid out.

Current assets are listed first. These are things that your business expects to convert into cash within one year. For example, your stock and materials.

Fixed assets are listed next. These are items that are needed to operate your business, but you don’t intend to sell. For example, your work van.

Liabilities

When it comes to understanding how to read a financial statement, your liabilities are what your company owes to others. For example, your work premises, any business loans, any outstanding debt on a supplier credit account, and any wages or taxes you owe.

Liabilities are listed either on the right-hand side of the balance sheet or underneath the assets. Typically, liabilities are listed in order of their due dates and split by ‘current liabilities’ and ‘long-term liabilities’.

Current liabilities are those items your business intends to pay off within 12 months. Long-term liabilities are the items due after this time period.

Equity

Depending on your balance sheet’s layout, equity can be found on the right-hand side or at the bottom, underneath assets and liabilities.

Equity is the amount you would have in your company if you sold all your assets and paid off all your liabilities.

Want an accountant to help with your trade business? Take a look at our post: ‘How to find an accountant that’s right for your business’.

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How to read a profit and loss statement

If you’re looking for how to read a profit and loss statement (P&L statement) or how to read an income statement, they are the same. The terms are used interchangeably.

Your profit and loss statement outlines:

  • Your revenue
  • Your business costs
  • Your net profit or loss

It shows what your business earned (its revenue) and lost (its business costs) over a specific time period, e.g. a year. You can then determine whether your business made a profit (net profit) or loss (net loss).

How to read a P&L statement

  • Revenue

Your company’s total sales figure sits at the top of the P&L statement and is called ‘gross revenue‘.

  • Costs

Working down the P&L statement, you then deduct the various costs you’ve incurred in order to make the revenue outlined above.

Costs include the ‘cost of sales‘, i.e. the expenses incurred from producing your services, and ‘operating expenses’ (your overheads, wages etc.). Income tax is another cost that must be deducted.

  • Net profit or losses

Your P&L ‘bottom line’ is your net profit or net losses. For example, how much your business earned or lost during that particular accounting period.

If your revenue is greater than your costs, your bottom line will show a net profit.

If your revenue is less than your costs, your bottom line will show a net loss.

Our bookkeeping for small businesses blog can shed more light on how to manage your books effectively.

How to read a cash flow statement

Your cash flow statement shows the money coming into your business and where it’s come from, and how money is being spent. It includes three main areas:

  • Cash flow from operating activities
  • Cash flow from investing activities
  • Cash flow from financing activities

Your cash flow statement shows your business’s ability to generate cash to pay its debts (or liabilities), fund its operating expenses (business costs), and investments.

Cash flow from operating activities

This is cash from running your business, e.g. the receipt of paid invoices, paying wages, making income tax payments etc.

Cash flow from investing activities

This is the cash sourced or used to invest in the future of your business. For example, buying a company van, workwear, or tools and equipment.

Cash flow from financing activities

This relates to the sources of cash from investors or banks. For example, paying back a bank loan.

For more support on cash flow in general, check out our article on how to manage your cashflow.

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Financial statement FAQs

How do you read a budget?

Understanding budgets is fairly straightforward. First, decide how often you want to analyse your budget, for example, weekly, monthly, or annually.

  • Your budget should have four columns: actual, budget, over budget, and % budget
  • Input your budget numbers frequently to keep your budget report up to date
  • Look for variances in the numbers to see how you’ve faired against your forecast

Take a look at our budget planner article for more information on this.

How do I file a confirmation statement?

If you are a limited company, you will also need to file an annual confirmation statement. Find out more about it and how to submit one over on our ‘What is a confirmation statement?’ blog.

A business bank account can help make financial reporting a little easier. Our ‘How to open a business bank account’ article provides lots of useful tips on how to open one.

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