Creating Financial Statements
What are financial statements?
Financial statements are reports that summarize important financial accounting information about your business. There are three main types of financial statements: the balance sheet, income statement, and cash flow statement.
Together, these statements provide you—and outside people like investors—a clear picture of your company’s financial position.
Common Types of Financial Statements
1. Balance Sheets
A balance sheet is a snapshot of your business finances as it currently stands. It tells you about the assets you own, and liabilities (i.e., debts) you owe, at a particular point in time.
How often your bookkeeper prepares a balance sheet for you will depend on your business. Some businesses get daily or monthly financial statements, some prepare financial statements quarterly, and some only get a balance sheet once a year.
For example, banks move a lot of money, so they prepare a balance sheet every day. On the other hand, a small Etsy shop might prepare a balance sheet every three months.
This sheet contains information about the company's liabilities, assets, and shareholders' equity, and is based on this accounting equation:
Shareholders’ equity is a term that refers to the net worth of a company. It reflects the amount of money that would be left if all assets were sold and all liabilities paid. This money belongs to the shareholders.
Assets are anything the company owns that has quantifiable value. This may include physical property (vehicles, real estate, unsold inventory, etc.), as well as non-physical property (patents, trademarks, etc.).
Liabilities refer to money the company owes to a debtor. This may include outstanding payroll expenses, debt payments, rent and utility payments, money owed to suppliers, taxes, bonds payable, and more.
Sample Balance Sheet Walkthrough
Let’s say you run a food cart selling ice cream.
At the end of June, you get a balance sheet from your bookkeeper. It looks like this:
June Balance Sheet
Not bad! It’s summer, your busiest time of year. One month passes.
At the end of July, your balance sheet shows this:
July Balance Sheet
Nice. You’ve added $1,000 to your retained earnings by saving more cash, even though your liabilities haven’t changed.
This is useful information. But it’s not the full picture.
Does your balance sheet tell you…
…how much ice cream you sold? No.
…how much cash you received? No.
…how much it cost you to make the ice cream you sold? No.
…how much you spent on expenses? No.
This is where the income statement comes in.
2. Income Statements
An income statement is a report that a company generates to communicate how much money the company has earned over a period of time. It shows you how much you made (revenue) and how much you spent (expenses).
Revenue: how much you earned from selling product or service
Cost of Goods Sold (COGS): the total amount it cost you to make the product or service
Gross Profit: tells you how profitable your products are
Gross Profit = Revenue - COGS
Operating Expenses: the cost of running your business, not including COGS
Net Profit: tells you how profitable your business is
Net Profit = Gross Profit - Operating Expenses
Sample Income Statement Walkthrough
Suppose we have an income statement for July that looks like this:
July Income Statement
You sold $1,000 worth of ice cream. If ice cream costs $4 each cup, that means you sold 250 ice cream cups.
What does the income statement tell us that the balance sheet doesn’t?
With this info, you know how many more ice cream cups you have left in inventory - and how many more you should be prepared to make next July.
What else? There are two expenses here besides interest expense: electricity and maintenance. Looking back over your income statements, you’ll be able to see which months you spend more on electricity, and roughly how often you need to pay for maintenance on your ice cream cart.
More importantly, you’ll be able to plan ahead for more expensive months (electricity-wise) and know roughly how much money to set aside for maintenance.
You can only get this kind of information from the income statement.
But what’s missing?
Does your income statement tell you…