Beginner’s Guide to Financial Statements

Whether you aspire to be an executive, an entrepreneur or an investor, it’s important to understand the basics of a financial statement. Financial statements offer crucial insights into a company’s financial health and serve as the basis for company-wide decisions.

As a project manager or executive, financial statements are the foundation for department budgets, operating activities, project budgets, and company goals and objectives. As an entrepreneur, they not only tell you where you are headed with your company, they can also help you sell your brand to potential investors.

This guide goes beyond the accounting statements’ definitions to explore various parts of these statements and what they mean. 

The simplest way to define financial statements is that they are reports which summarize the financial activities and accounting information of a business over a set period.¹ They allow for assessments of the probability that a company can generate cash, pay off its debts, and remain profitable over time.

Financial statements give you, as a business owner or executive-level employee, an idea of your company’s fiscal health and aid in decision-making. For example, if your company is currently experiencing high profits and steady cash flow, you might be more inclined to take a risk such as entering an untested market. 

A financial statement is not limited to a single type of report. There are multiple varieties, which offer different information about a company and how it handles its money.

An income statement details a company’s reported income over a specific period, such as a quarter or a fiscal year.² Each income statement will contain a headline indicating the period on which it is reporting. It will then outline:

• Revenue: Income gained through regular operations such as sales of goods and services
• Expenses: Regular costs a business must pay, including costs of goods, general and administrative costs, research and development and loan interest
• Gains: Money made from atypical activities such as selling assets
• Losses: Atypical costs such as lawsuit settlements

A balance sheet showcases a company’s total assets and how the company owns or has financed them.³ Each balance sheet has sections showing the company’s assets, liabilities and shareholder’s equity—usually presented with assets on one side and liabilities and equity on the other. They are used to calculate financial ratios that give a glimpse into a company’s performance.

A cash flow statement is a summary of all cash moving into and out of a company.⁴ It shows how a company is earning money, investing it and funding operations. It gives an idea of how well a company can meet its expenses. 

Shareholders’ equity is what remains after subtracting liabilities from assets. This statement explains the account’s valuation to people who own company shares.⁵ This financial statement goes in-depth to show how a company raises and distributes its capital. 

Let’s review the essential types of financial statements.

An income statement is also called a profit and loss statement.⁶ It details revenues and expenses. Expenses include general costs and financing activities such as rent, operational costs and equipment leases.

Revenue refers to money made from selling goods or services. The profit and loss statement first lists total revenue and then deducts the cost of goods sold. Next, the sheet shows general expenses and deducts them from the gross profit. At the bottom, you will see a company’s net profit or net loss for the year.

A balance sheet goes into further detail about assets and liabilities.⁷ Assets include cash, cash equivalents, property, equipment, investments and accounts receivable. Liabilities include accounts payable, taxes, debt and deferred revenue. Finally, the balance sheet contains information about shareholder equity.

At the top of each column, the balance sheet will tell how to read each figure. For example, some companies shorten figures by thousands or millions, so $650 could mean $650,000 or $6.5 million. Each column will tell how the company abbreviates its numbers, along with the period over which they were measured. Finally, a balance sheet typically compares multiple periods such as years or quarters, showing how the company’s performance has changed over time.

Cash flow statements are similar to income statements, but they only show how much cash a business has on hand.⁸ It breaks cash flow into categories, including operating, investing and financing.

Each statement shows the change in cash flow and the total of cash a company has on hand. Cash flow statements often include projected cash flows compared to actual cash on hand, allowing a company to see if it is hitting its projections.

A statement of shareholders’ equity shows how much the company has left when its liabilities are paid. Companies usually pay a portion of their profits to owners and shareholders. When the shareholders’ equity is positive, the company can pay more to these investors. When it’s negative, it could signal impending financial issues.

The other financial data used in each financial statement allows you to calculate aspects of a company’s financial performance.

These ratios, including gross margin and net profit margin, tell you how much the company has profited once it has covered its operational expenses and other expenses.

• Gross profit margin reflects how much a company earns relative to its costs;⁹ a high gross profit margin can indicate a company that is more efficiently operating its business
• Net profit margin refers to the actual profit of a company after paying its expenses

Liquidity ratios can tell how well a company can pay its debts without raising more money.¹⁰ Common liquidity ratios include the current ratio and the quick ratio.

• Calculated by dividing current assets by current liabilities, the current ratio refers to a company’s ability to pay its current liabilities within the year
• The quick ratio shows how a company can meet its short-term obligations; calculate it by adding cash, marketable securities and accounts receivable, then dividing the total by current liabilities

Any company needs the cash flow to pay off its debts. The most common solvency ratio, the debt-to-equity ratio, is calculated by dividing the company’s liabilities by its shareholder equity.

To operate well, a company should be able to turn over its inventory and its accounts receivable quickly. Efficiency ratios will tell you about how long it takes companies to sell inventory and to collect on bills.

Many common mistakes can affect financial statements. By definition, accounting statements require accurate record-keeping. An accountant may forget to log certain data into accounting books or might enter numbers incorrectly when calculating ratios.

Your best defense is to keep electronic records and use software that integrates with your accounting systems to automate financial statements and offer data visualizations that can signal you of potential errors.

As part of the online MBA program at Yeshiva University, you will explore the analysis of businesses in depth. Our faculty of business leaders not only explain financial statements, they share their expertise and experience in the industry with students. The online program allows you to advance your career and gain valuable connections, all while continuing to meet your non-academic obligations.

Join us to learn all about modern business leadership from innovative faculty and a close-knit student body. Take the first step by contacting an admissions outreach advisor today.