Balance Sheets, Income Statements and Cash Flow Statements Explained

Three reports, three questions

The balance sheet shows your position on one date. The income statement shows profit over a period. The cash flow statement shows how cash moved in and out.

Think of them as a photo, a scoreboard and a bank trail.

• Balance sheet: what the business owns and owes today.
• Income statement: revenue minus expenses over a month, quarter or year.
• Cash flow statement: actual cash that arrived and left, grouped by purpose.

Looking at only one of them can mislead you. A business can show a profit and still run out of cash. Our piece on cash flow vs. profit explains why.

Reading a balance sheet

A balance sheet lists assets, liabilities and owner's equity. Assets equal liabilities plus equity, which is why it is called a balance sheet.

Assets are what the business owns: cash, receivables, inventory, equipment. Liabilities are what it owes: payables, loans, taxes due. Equity is what is left for the owners.

Here is an illustrative example. A shop holds $60,000 in cash, stock and equipment and owes $25,000. Equity is $35,000. If the shop borrows $10,000 and keeps it as cash, assets and liabilities both rise by $10,000, and equity is unchanged.

Lenders pay attention to how much debt you carry compared with equity. See assets, liabilities and equity for more detail.

Reading an income statement

An income statement starts with revenue, subtracts the cost of goods and operating expenses, and ends at net profit. It shows performance, not cash.

The usual layout runs top to bottom:

1. Revenue, or sales
2. Cost of goods sold, leaving gross profit
3. Operating expenses such as rent, payroll and marketing
4. Interest and taxes
5. Net profit

Watch for the timing rules. Under accrual accounting, you record a sale when you earn it, not when the customer pays. That is why profit and bank balance rarely match. Our guide to the income statement walks through each line.

Reading a cash flow statement

The cash flow statement sorts cash movement into operating, investing and financing activity. It shows where cash really came from and where it went.

Operating cash covers day-to-day business: customer payments in, supplier and payroll payments out. Investing covers purchases of equipment and similar assets. Financing covers loans received, loan payments and owner contributions or withdrawals.

If operating cash is negative while profit is positive, check receivables and inventory. Money may be tied up in unpaid invoices or stock. For the full breakdown, see what goes on a cash flow statement.

How the three statements connect

Net profit from the income statement flows into equity on the balance sheet, and the cash flow statement explains the change in the balance sheet's cash line.

The statements are not separate. Profit raises equity. A sale on credit raises receivables, not cash. Paying down a loan lowers cash and lowers liabilities.

A simple check: starting cash plus the net cash flow for the period should equal ending cash on the balance sheet. If it does not, something is miscoded. Reconciling your bank accounts monthly catches most of these errors early.

What lenders and funders look for

Funders compare revenue trends, margins, existing debt and cash on hand. Clean statements speed up any review.

For many working capital and revenue-based products, funders focus mainly on bank statement deposits. ROI Funder asks for the application plus 3 months of business bank statements, and considers files with 6+ months in business, $20,000+ monthly revenue and 500+ FICO. Larger or lower-cost options such as SBA loans usually require full financial statements and tax returns.

Either way, knowing your own numbers lets you judge whether a repayment fits. Use the revenue share guide before you accept any offer.