Financial Statements Explained: Balance Sheet, Income Statement & Cash Flow

Introduction

Financial statements provide a clear picture of a company’s financial health. Whether you’re a business owner, investor, or accountant, understanding these reports is essential for making informed decisions.

In this guide, we’ll break down the three key financial statements—Balance Sheet, Income Statement, and Cash Flow Statement—explaining their structure, purpose, and how they work together.

1. Balance Sheet: A Snapshot of Financial Position

What Is a Balance Sheet?

The Balance Sheet provides a summary of a company’s financial position at a specific point in time. It shows what the business owns (assets), what it owes (liabilities), and what’s left for the owners (equity).

Structure of a Balance Sheet

A balance sheet follows the fundamental accounting equation:

Key Components

• Assets – Resources owned by the company (cash, inventory, equipment, accounts receivable).

• Liabilities – Financial obligations (loans, accounts payable, taxes owed).

• Equity – Owner’s investment in the business (retained earnings, share capital).

Why It Matters

• Helps determine financial stability and liquidity.

• Shows whether a business has more assets than liabilities.

• Used by lenders and investors to assess risk.

✅ Example: If a company has £200,000 in assets and £120,000 in liabilities, its equity is £80,000. This means the business is worth £80,000 to its owners.

2. Income Statement: Tracking Profitability

What Is an Income Statement?

The Income Statement (also called the Profit & Loss Statement) shows a company’s financial performance over a period (month, quarter, or year). It details revenues, expenses, and net profit or loss.

Structure of an Income Statement

Key Components

• Revenue – Money earned from sales or services.

• Cost of Goods Sold (COGS) – Direct costs of producing goods or services.

• Gross Profit – Revenue minus COGS.

• Operating Expenses – Costs related to running the business (rent, salaries, marketing).

• Net Profit (or Loss) – The final result after deducting all expenses.

Why It Matters

• Measures business profitability over time.

• Helps identify trends in revenue and expenses.

• Crucial for setting financial goals and improving cost efficiency.

✅ Example: If a company earns £100,000 in revenue and incurs £70,000 in total expenses, its net profit is £30,000.

3. Cash Flow Statement: Understanding Liquidity

What Is a Cash Flow Statement?

The Cash Flow Statement shows how cash moves in and out of a business. Unlike the income statement, which includes non-cash items (such as depreciation), the cash flow statement focuses on actual cash transactions.

Structure of a Cash Flow Statement

It consists of three sections:

1️⃣ Operating Activities – Cash generated from business operations (sales, expenses, taxes).

2️⃣ Investing Activities – Cash spent on assets (equipment, property, investments).

3️⃣ Financing Activities – Cash from loans, investors, or repaying debt.

Why It Matters

• Shows if a business can meet short-term obligations.

• Helps assess liquidity and financial flexibility.

• Important for investors and lenders evaluating financial health.

✅ Example: A company earns £50,000 from sales but spends £40,000 on expenses and investments. The cash flow statement shows a positive cash flow of £10,000, indicating strong liquidity.

How These Financial Statements Work Together

Each financial statement serves a different purpose, but they are interconnected:

• The Income Statement calculates net profit, which is added to equity on the Balance Sheet.

• The Cash Flow Statement explains changes in cash balances, affecting both the balance sheet and income statement.

By analyzing all three, business owners and investors get a complete financial picture.

Conclusion

Understanding the Balance Sheet, Income Statement, and Cash Flow Statement is essential for managing a successful business. These reports provide insights into financial health, profitability, and cash management.