Balance sheets, income and cash flow statements: Three pillars of financial understanding

Balance sheets, income statements, and cash flow statements are all financial statements that help you track and gain insights into your business. Learn about what they are, their different purposes, and what goes into each in this helpful primer.

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Balance sheets, income statements, and cash flow statements are tools that offer up incredible insights into your business. You can see if you’re generating a profit or can invest more in your business. You can see how different sectors or your business as a whole is performing compared to peers. You’ll also learn a ton about your operations – like what it costs to provide your service or make your product and when your costs are highest.

Understanding these documents – when to use them and how to create them, are important parts of running a small business. Below is a primer on these three financial statements to get you started.

Balance sheets: Your business snapshot at one point in time

What is a balance sheet?

A balance sheet is a tool that tracks assets and liabilities and can be used to determine your company’s net worth at the moment. Often, it is prepared monthly or quarterly.

What goes on a balance sheet?

Most balance sheets small businesses use are organized around three factors: assets, liabilities, and owner’s equity: 

  • Some business owners like to use Assets = Liabilities + Owners’ Equity. 

  • Others arrange it to show Owners’ Equity = Assets - Liabilities

  • A third option is Liabilities = Assets - Owners’ Equity

Whichever you choose is just fine; just be sure what’s on both sides balances out! That’s what a balance sheet is all about.

Assets at a glance Liabilities at a glance

Everything your business owns! The things you use to run your business: the buildings, cash received, accounts receivable, equipment, and inventory in stock and ready for sale are all assets.

Some of these assets are current, like cash and inventory – anything that may be liquid within a year. You’ve got them on hand. Others are fixed or non-current assets – property, equipment, and things like patents and licenses – that aren’t expected to be liquid within a year.

Everything your business owes! In this column, you’d track everything you owe, like loans to a bank.

Like assets, you can sub-categorize these as current liabilities, like accounts payable, wages, and short-term debt. Non-current liabilities would be longer-term debt or lease obligations and deferred revenue. 

When you create a balance sheet – put the liabilities at the top! In case of bankruptcy, you’d need to pay liabilities back first.

How does a balance sheet help a small business?

When kept up to date, a balance sheet is like a temperature check – a great way to get an at-a-glance insight into your company’s health. A balance sheet can also help with data-based decision-making.

With a balance sheet, you can understand your debt ratio by dividing total liabilities by total assets (Debt Ratio = Total Liabilities ÷ Total Assets). Each industry has a different acceptable range of debt ratio. 

That’s because debt ratio relates to leverage – or using borrowed capital to invest in your business because you expect to be able to pay it off through the profits from those investments.

Leverage is often good, it can help you launch or expand before you could otherwise. Too much leverage can hurt your business. A higher debt ratio shows that you are more highly leveraged. 

Being over-leveraged means you have borrowed more than you can expect to pay back easily. 

Knowing how much your business is leveraged or over-leveraged helps you understand if you can take on more business debt and if lenders may consider you a risk.

Investors and lenders interested in your business can also request a balance sheet. Want to apply for an SBA 7(a) loan? You’ll need a balance sheet! 

Likewise, an external auditor might review your balance sheet to ensure you follow any reporting laws relevant to your business. Some businesses filed as corporations will also need a balance sheet come tax time.

Should it come time to sell your business someday, a balance sheet helps with valuation. 

Get a SCORE balance sheet template.

Income statements: Your business view over time

What is an income statement?

An income statement is another essential financial statement for small businesses focusing on revenue, expenses, gains, and losses. It provides a tally of income and expenses during a set period. This reporting period is usually monthly, quarterly, or annually. You may also hear an income statement be called a P&L – or profit and loss statement.

You can create an income statement for your whole business or a unique segment or business line. 

What goes on an income statement?

Your income statement will include revenue and expenses during the reporting period. 

You'll also add the total costs of goods sold, or COGS, the total costs of component parts that make up your product or service. 

Gross profit will reveal your revenue minus COGS. Some factors include labor and material expenses, distribution costs, and direct production expenses.

Operating income is your gross profit minus operating expenses – rent, utilities, office supplies – all the indirect costs of your business.

You can calculate your net income once you factor in interest and taxes – what you owe in debt and your tax burden for the period.

You'll also factor in depreciation – the lost value of assets like your equipment and property over time.

How does an income statement help a small business?

Like a balance sheet, an income statement offers insights into your financial position. You’ll know if you are generating a net profit or loss. You’ll get insight into expected future performances and can switch up your strategy if you’ve missed a target. Investors also monitor P&L statements to see which companies may be smart to invest in. Lenders look to ensure you can pay off your liabilities.

Examining your monthly and aggregated income statements can provide helpful information about your business and help you spot trends, forecast growth, and more.

Get a free 12-month income statement template from SCORE.

Cash flow statements: What your business spent and made over a certain time period

What is a cash flow statement?

Money in, money out is the gist of a cash flow statement. It shows what both are for your business over a period of time. Cash flow can be a significant stressor for small businesses. A cash flow statement is a wise financial document that helps you keep better track of money going into and out of your business. The projections you can get from the cash flow statement help with planning around working capital needs and future expenses, too.

If you’ve got a business plan, a cash flow statement would fit right into the plan's financial section.

What goes on a cash flow statement?

Your cash flow statement will include a starting balance and two main categories of information. First will be cash received. That’ll be income from sale and interest and loan proceeds. You’ll also track cash paid out. That includes payroll, rent, purchases, utilities, and other payments.

Tally up your cash received. Tally up your cash paid out. Subtract cash paid out from cash received, and you’ll have your business’s cash position for the end of the month, quarter, year, or whatever recording period you’re tracking.

How does a cash flow statement help a small business?

Knowing what your cash flow looks like for any period is tremendously helpful for tracking growth, gaining stability, and planning for the future. 

Positive cash flow means you have an excess of cash. Negative cash flow means you're spending more than you’re receiving. Even profitable businesses can have issues with cash flow, and many small businesses experience significant seasonal flux. Negative cash flow can feel like a bad thing – but it can also be a sign of expansion and growth. Excess cash on hand may feel good, but you could use idle money for growth.

With a better sense of cash flow over a month, quarter, or year, you'll quickly see crucial financial health data about your company. With that, you can adjust your strategies, manage your budget, and more. 

Like the other financial documents discussed, a cash flow statement also helps an investor better understand whether they want to invest in your business.

Get a free 12-month cash flow statement template from SCORE.

Whether you make and maintain your own financial statements in a spreadsheet or outsource to a financial professional like a bookkeeper or accountant, these documents are as helpful as they are important for tracking your company’s financial health.

Want to have a conversation about your small business banking needs? We’d love to talk.