Financial statements are essential tools for any entrepreneur looking to understand the financial health of their business. Whether you’re starting out or have an established business, understanding how to read and analyze these reports is crucial for effective decision-making. In this guide, we'll explore the four core financial statements with real-life examples from an e-bike manufacturing company: Balance Sheet, Income Statement (Profit & Loss Statement), Cash Flow Statement, and Statement of Changes in Equity (or Retained Earnings Statement). By the end of this blog, you’ll have a comprehensive understanding of how these statements work and how they can inform your business decisions.
1. The Balance Sheet: A Snapshot of Financial Health
The Balance Sheet provides a snapshot of a company’s financial health at a specific point in time. Learn more about our Financial Strategy Services. It shows what the company owns (assets), what it owes (liabilities), and the owner’s equity.
Components of a Balance Sheet
Assets: Divided into current and non-current (long-term) assets.
Current Assets: Cash, accounts receivable, and inventory.
Non-Current Assets: Long-term investments like equipment and property.
Liabilities: Divided into current and long-term liabilities.
Current Liabilities: Accounts payable and short-term loans.
Long-Term Liabilities: Debts like bank loans payable over more than one year.
Equity: Represents the net worth of the company after all liabilities are settled.
Balance Sheet Example for Green Wheels Ltd. (an E-Bike Manufacturing Company)
Balance Sheet for Green Wheels Ltd. | As of Dec 31, 2023 |
Assets | |
Current Assets | |
- Cash | $30,000 |
- Accounts Receivable | $25,000 |
- Inventory | $40,000 |
Non-Current Assets | |
- Manufacturing Equipment & Machinery | $120,000 |
- Property | $90,000 |
Total Assets | $305,000 |
Liabilities | |
Current Liabilities | |
- Accounts Payable | $20,000 |
- Short-Term Loan | $10,000 |
Long-Term Liabilities | |
- Bank Loan | $80,000 |
Total Liabilities | $110,000 |
Equity | |
- Owner’s Equity | $195,000 |
Total Liabilities & Equity | $305,000 |
2. The Income Statement: Measuring Profitability
The Income Statement, or Profit & Loss Statement, shows how much revenue a company earned and what expenses were incurred during a specific period. Check out our Bookkeeping Services to keep your financial records in order. The bottom line is the net profit or loss.
Components of an Income Statement
Revenue: Income from the sale of e-bikes.
Cost of Goods Sold (COGS): Direct costs of manufacturing the e-bikes, including raw materials and labor.
Gross Profit: Revenue minus COGS.
Operating Expenses: Costs of running the business, such as salaries, rent, and utilities.
Operating Profit (EBIT): Gross profit minus operating expenses.
Net Profit: Final profit after accounting for all expenses, interest, and taxes.
Income Statement Example for Green Wheels Ltd.
Income Statement for Green Wheels Ltd. | Year Ending Dec 31, 2023 |
Revenue | $300,000 |
Cost of Goods Sold (COGS) | $150,000 |
Gross Profit | $150,000 |
Operating Expenses | |
- Salaries | $50,000 |
- Rent | $15,000 |
- Utilities | $5,000 |
- Marketing | $10,000 |
Total Operating Expenses | $80,000 |
Operating Profit (EBIT) | $70,000 |
Interest Expense | $6,000 |
Taxes | $10,000 |
Net Profit | $54,000 |
3. The Cash Flow Statement: Tracking Cash Movement
The Cash Flow Statement details how cash enters and leaves your business. Learn how we can assist with Cash Flow Management Services. It’s divided into three sections: Operating Activities, Investing Activities, and Financing Activities.
Components of a Cash Flow Statement
Cash Flow from Operating Activities: Cash generated from core business activities (e.g., net profit, adjustments for non-cash items, changes in working capital).
Cash Flow from Investing Activities: Cash used for purchasing or selling assets like equipment.
Cash Flow from Financing Activities: Cash obtained from loans or investments, or paid out as dividends.
Cash Flow Statement Example for Green Wheels Ltd.
Cash Flow Statement for Green Wheels Ltd. | Year Ending Dec 31, 2023 |
Cash Flow from Operating Activities | |
- Net Profit | $54,000 |
- Depreciation | $8,000 |
- Increase in Accounts Receivable | -$5,000 |
- Increase in Inventory | -$10,000 |
- Increase in Accounts Payable | $7,000 |
Net Cash from Operating Activities | $54,000 |
Cash Flow from Investing Activities | |
- Purchase of Equipment | -$25,000 |
Net Cash from Investing Activities | -$25,000 |
Cash Flow from Financing Activities | |
- Loan Proceeds | $20,000 |
Net Cash from Financing Activities | $20,000 |
Net Increase in Cash | $49,000 |
Opening Cash Balance | $30,000 |
Closing Cash Balance | $79,000 |
4. Statement of Changes in Equity: Tracking Retained Earnings
The Statement of Changes in Equity shows changes in the equity portion of the balance sheet over a specific period. Discover how we support Equity Planning and Management. It details how profits are retained, dividends are paid, or additional investments are made.
Components of the Statement of Changes in Equity
Opening Balance: Equity at the start of the period.
Net Profit: Profit earned during the period.
Dividends: Profits paid out to shareholders.
Additional Investments: Any additional funds invested by the owner(s).
Statement of Changes in Equity Example for Green Wheels Ltd.
Statement of Changes in Equity for Green Wheels Ltd. | Year Ending Dec 31, 2023 |
Opening Balance | $150,000 |
Net Profit | $54,000 |
Dividends Paid | -$9,000 |
Additional Investments | $0 |
Closing Balance | $195,000 |
Key Insights for Entrepreneurs
Balance Sheet Insight: Assets must be greater than liabilities to maintain a positive equity balance. Green Wheels Ltd. has $195,000 in equity, showing financial stability.
Income Statement Insight: Monitor profitability closely. A net profit of $54,000 on $300,000 in revenue gives Green Wheels Ltd. an 18% profit margin, which is a good indicator of business efficiency.
Cash Flow Statement Insight: Profitability does not always mean positive cash flow. Green Wheels Ltd. has a net profit of $54,000, but due to investments and financing activities, the cash flow is affected differently, leading to an ending cash balance of $79,000.
Statement of Changes in Equity Insight: Retained earnings are crucial for funding future growth. Green Wheels Ltd. retained $45,000 ($54,000 net profit minus $9,000 dividends), which can be reinvested into the business.
Conclusion: Bringing It All Together
Understanding these four financial statements is fundamental for entrepreneurs who want to make informed decisions, plan for growth, and manage risks. The balance sheet provides a snapshot of your company’s financial position, the income statement shows profitability, the cash flow statement reveals liquidity, and the statement of changes in equity tracks retained earnings and investments.
By mastering these financial statements, you gain better control over your business, allowing you to make strategic decisions, navigate challenges, and capitalize on opportunities for growth.
Ready to Gain Financial Clarity?
At Celeste Business Advisors, we empower entrepreneurs by providing comprehensive financial guidance tailored to your needs. Our team is Fathom Certified, XERO Certified, QBO Certified, and includes seasoned CPAs and CMAs. Schedule a free consultation today to understand how we can support your financial journey.