Financial statements are essential tools for businesses, investors, and regulators to assess a company’s financial health. Whether you're a business owner or an investor, understanding these documents is crucial for making informed decisions. In this guide, we’ll break down what financial statements are, how they’re used in the real world, and the three main financial statements you need to know.

By the end of this article, you’ll have a clear understanding of income statements, balance sheets, cash flow statements, and how you can utilize them when running your creative business.

What Are Financial Statements?

Financial statements are numerical records that summarize a company’s financial activities, position, and performance either over a specific period or as of a specific point in time. They include the income statement, balance sheet, and cash flow statement (more on those below). Financial statements are used by...

• Business owners to track profitability, degree of financial leverage (debt-to-assets ratio), and cash flow.

• Investors to assess financial health, growth potential, and risks.

• Lenders to determine creditworthiness, or the amount and size of a loan they can offer the business.

• Regulators to ensure compliance with financial laws.

Without financial statements, making data-driven business or investment decisions would be nearly impossible.

The Three Main Financial Statements

The 3 main financial statements are the backbone of financial reporting. Each serves a unique purpose and when analyzed together, they provide a complete picture of a business’s financial situation. Let's explain the three main statements below...

The Income Statement

The income statement (also called a profit and loss statement) shows a company’s revenues, expenses, and profits over a specific period (like quarterly or annually). The income statement can be used to evaluate profitability trends and operational efficiency. Income statements follow this equation: Income - Expenses = Profit

Key components of the Income Statement include:

• Revenue: Total income from goods or services sold. Download our free Business Income Cheat Sheet for a useful list of examples.

• Expenses: The costs you incur to run your business - gear, travel, rent, utilities, office supplies, etc. Download our free Business Expense Cheat Sheet for a helpful list of example expenses.

• Net Income: This is your profit, or your revenue minus your expenses. This is generally the amount that carries to your individual income tax return (Form 1040) as your personal income.

Take a look at our guide to income statements to learn more.

The Balance Sheet

The balance sheet provides a snapshot of a company’s financial position at a specific point in time (like on a specific date). A strong balance sheet indicates financial stability, while excessive liabilities could be a sign of financial risk. Balance sheets follow this fundamental equation: Assets = Liabilities + Shareholders’ Equity

The Balance Sheet is divided into the following key sections:

• Assets: What the company owns - cash, inventory, property.

• Liabilities: What the company owes - debts, loans, accounts payable.

• Equity: The equity owned by the business owner(s) after liabilities have been deducted from assets.

Check out our Balance Sheet Guide to learn more.

The Statement of Cash Flows

The cash flow statement tracks how cash enters and exits a business over a period of time. It's a bit less common than the income statement and balance sheets, but it can be very useful for businesses seeking to optimize cash flows over time. Unlike the income statement (which includes non-cash items like depreciation), the cash flow statement reveals a company’s liquidity—its ability to pay bills and fund growth.

The Cash Flow Statement is divided into three sections:

1. Operating Activities: Cash from core business operations, like the main products and services you sell.

2. Investing Activities: Cash used for investments - buying equipment, real estate, financial assets, etc.

3. Financing Activities: Cash from private investments, loans, dividends, or stock issuance.

"Financial statements are financial records that summarize a company’s financial activities, position, and performance either over a specific period or as of a specific point in time."

Conclusion

Financial statements are incredibly important for evaluating a company’s performance and making sound financial decisions. The 3 main financial statements - the income statement, balance sheet, and cash flow statement - each serve distinct yet interconnected roles in financial analysis.

Whether you're managing a business, investing in stocks, or securing a loan, mastering these documents will help you navigate the financial world with confidence.

Frequently Asked Questions (FAQs)

What are the 3 main financial statements?

The 3 main financial statements are the income statement, balance sheet, and cash flow statement. Together, they provide a comprehensive view of a company’s financial health.

Why are financial statements important?

Financial statements help businesses track performance, assist investors in making decisions, and ensure regulatory compliance with the IRS (Internal Revenue Service) and SEC (Securities and Exchange Commission). They are critical for transparency and accountability.

What’s the difference between an income statement and a balance sheet?

An income statement shows income and expenses over a certain period of time, while a balance sheet provides a snapshot of assets, liabilities, and equity as of a specific date.

How often are financial statements prepared?

Public companies are required to file quarterly and annual statements. Private businesses, on the other hand, have no such requirements - they can prepare them monthly, quarterly, annually, or all three, depending on their needs.

Can financial statements be audited?

Yes, independent auditors often review financial statements to ensure accuracy and compliance with accounting standards such as GAAP (Generally Accepted Accounting Principles) in the US, and IFRS (International Financial Reporting Standards) in most non-US countries. All publicly-traded companies must be audited annually, while private companies generally only need to be audited when they are seeking investments or loans.

Disclaimer: the information provided in this article is for educational purposes only and does not constitute tax, accounting, investing, legal, or financial advice. The information in this article does not take into account your unique financial or business situation or goals, and YCCPA cannot be responsible for reader's financial decision-making. YCCPA's goal is to educate and support you on your creative business journey.

Written by David Kindness, CPA

David is a CPA (Certified Public Accountant) and professional photographer, videographer, and designer based in San Diego, California. Learn more.

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