Financial Statements

The Story Your Numbers Tell

🔄 Quick Recall: In the previous lesson, we reconciled our books against bank statements. Now we’ll use those verified records to produce the reports that reveal how your business is actually performing.

You’ve been recording transactions and reconciling your bank accounts. That data is valuable—but raw transaction lists don’t tell you much. Financial statements turn your data into answers.

By the end of this lesson, you’ll understand and produce the three essential financial statements.

The Three Essential Statements

Every business needs three financial reports:

1. Income Statement (Profit & Loss) — Are you making money?
2. Balance Sheet — What’s the business worth right now?
3. Cash Flow Statement — Where is the cash going?

Each answers a different question. Together, they give you the complete financial picture.

Statement 1: Income Statement (P&L)

The income statement covers a period of time—a month, quarter, or year. It’s simple:

Revenue - Expenses = Net Income (or Net Loss)

Sample Income Statement

Freelance Design Business — January 2026

This tells you: the business earned $9,700 and spent $2,450, resulting in $7,250 profit for January.

What to Watch For

• Revenue trends. Is income growing, flat, or declining?
• Expense ratios. What percentage of revenue goes to each category?
• Profit margin. Net Income / Revenue. Above 20% is healthy for service businesses.
• Unusual spikes. A sudden jump in any expense category needs investigation.

✅ Quick Check: If a business has $15,000 in revenue and $12,000 in expenses, what’s the profit margin?

Statement 2: Balance Sheet

The balance sheet is a snapshot of a single moment—what you own, what you owe, and what’s left.

Assets = Liabilities + Equity

Sample Balance Sheet

Freelance Design Business — As of January 31, 2026

Notice: $23,700 = $950 + $22,750. It balances.

What to Watch For

• Liquidity. Can you pay your bills? Compare current assets (cash, receivables) to current liabilities.
• Receivables aging. How old are your unpaid invoices? Old receivables may not be collectible.
• Debt load. How much of your assets are financed by debt vs. your own equity?

Statement 3: Cash Flow Statement

This is the statement most small businesses ignore—and the one that kills them.

A business can be profitable on paper and still run out of cash. The cash flow statement shows where cash actually moved.

Three sections:

Operating Activities

Cash from day-to-day business operations.

• Cash received from clients
• Cash paid for expenses
• Net cash from operations

Investing Activities

Cash spent on or received from long-term assets.

• Equipment purchases
• Asset sales

Financing Activities

Cash from owners or lenders.

• Owner investments
• Loan proceeds or repayments
• Owner draws

Sample Cash Flow Statement

January 2026

Revenue was $9,700 but cash received was only $7,200. The $2,500 difference? That’s in Accounts Receivable—clients who haven’t paid yet.

The Profit vs. Cash Trap

This is critical: Profit is not cash.

Your income statement shows $7,250 profit. But your cash only increased $1,950. Why?

• $2,500 in revenue hasn’t been collected yet (receivables)
• $800 went to equipment (not an expense on the income statement)
• $2,000 was taken as an owner’s draw

Many profitable businesses fail because they confuse profit with cash. Don’t be one of them.

Try It Yourself

Using your chart of accounts from Lesson 2 and transactions from Lesson 3, try building a simple income statement for a hypothetical month. List all revenue accounts, all expense accounts, and calculate net income.

Using AI to Generate Statements

Try this prompt with your transaction data:

“Here are my business transactions for January [paste list]. Generate an income statement, balance sheet, and cash flow statement. Format each as a table.”

AI can compile these quickly. Your job is to review for accuracy and understand what the numbers mean.

Key Takeaways

• Income Statement shows profitability over a period (Revenue - Expenses = Net Income)
• Balance Sheet shows financial position at a point in time (Assets = Liabilities + Equity)
• Cash Flow Statement shows where cash actually moved
• Profit and cash are different things—monitor both
• Together, these three statements give you the complete financial picture

Up Next

In Lesson 6: Accounts Payable and Receivable, you’ll master the two accounts that most directly affect your cash flow—money you owe and money owed to you.