Running a small business means juggling plenty of paperwork—receipts, invoices, bank statements, payroll records—you name it.
However, among all the documents, your financial statements are the ones that truly tell the story of your organization’s economic health. These statements are based on Generally Accepted Accounting Principles (GAAP), providing you with consistent and reliable insights.
What are financial statements? Simply put, they’re the formal reports that show how money flows through a business. There are different types of financial statements (which we’ll discuss in a moment), and each contributes to managing cash flow, attracting investors, securing loans, and planning for growth.
That’s not all: they’re also mission-critical during your most important financial moments, like tax season, audits, and financing applications.
If you want to ensure you have enough cash flow for your operations, are eager to attract a new investor or secure a loan, or you simply want to take control of your business’ finances, here’s everything you need to know about financial statements, so you can keep things in order and prepare for growth.
The 4 primary financial statements (and how to read them)
Before you can use financial reports to guide decisions, you need to understand what each one actually tells you. These four statements form the foundation of good accounting—and when reviewed together, they paint a full picture of your business’s health.
Income statement (Profit & Loss)
First up is your income statement, also known as the profit and loss statement. It’s one of the most commonly used financial reports, providing a snapshot of revenue, expenses, and net profit or loss over a specified period (such as a quarter or a year). It gives a clear view of your company’s financial performance over a specified period.
Key line items on your P&L include:
- Gross profit: Revenue minus cost of goods sold (COGS).
- Operating expenses: Day-to-day costs like rent, salaries, marketing, and utilities.
- Net income: What’s left after all of the expenses—your bottom line, including non-cash expenses and taxes earnings.
What should you look for in your P&L? It helps you answer big questions like whether you’re profitable, or if you’re overspending (and where). For example, are operating expenses creeping up faster than revenue?
Pro tip: Many business owners misunderstand “net profit” vs. “cash in the bank,” but they’re not the same. Your income statement shows profitability, not liquidity.
For example, you may show a profit on paper, but still struggle with cash flow if customers haven’t paid their invoices. That’s why it’s critical to view income statements alongside other reports (like the cash flow statement).
Balance sheet
Your balance sheet is a snapshot of your business’s financial position at a specific point in time. Unlike the income statement (which covers a span of time), the balance sheet shows what your business owns (assets), what it owes (liabilities), and what’s left over for the owner (equity) at that exact moment. It helps you evaluate your company’s financial position and solvency.
Here’s an important equation for balance sheets: Assets = Liabilities + Owner’s Equity
Let’s break it down:
- Assets include items such as cash, inventory, equipment, and accounts receivable. These reflect what the company owns.
- Liabilities are what you owe (like loans, credit card balances, or unpaid bills), including accounts payable and both current and non-current liabilities.
- Owner’s Equity is the value that remains for you as the business owner after liabilities are subtracted from assets. This reflects your company’s assets on paper.
What should you look for in your balance sheet? Use this financial statement to assess financial stability. Are your liabilities growing faster than your assets? This could signal financial trouble. Reviewing your company’s balance sheet regularly can prevent surprises.
Cash flow statement
The cash flow statement tracks the movement of cash in and out of your business over a specified reporting period. It categorizes cash based on business activities, including daily operations, investments, and financing.
It follows three main categories:
- Operating activities: Cash generated from day-to-day business (like customer payments and supplier expenses).
- Investing activities: Cash used for or earned from buying and selling assets (like equipment or property).
- Financing activities: Cash from loans, investor funding, or owner contributions.
While your income statement shows profitability, the cash flow statement shows liquidity, or how much actual cash your business has on hand. Free cash is key here.
And that’s a big deal, because even a profitable business can run out of cash if payments are delayed, expenses spike, or too much money is tied up in inventory. Studies show that most small businesses report at least some cash flow issues.
What should you look for in your cash flow statement? Look for patterns in cash gaps or seasonality. Are there times of the year when you consistently dip into the red? Are there significant gaps between when you invoice customers and when cash comes in? Recognizing these trends can help you plan ahead and stay in control.
Statement of retained earnings
When your business makes money, where is that money going? That’s what the statement of retained earnings seeks to answer—it shows how your business’s profits are either reinvested or distributed over time.
After covering expenses and taxes, your net income doesn’t just disappear. It either stays in the business to fund future growth or gets distributed to owners or shareholders.
These reinvested earnings appear in shareholders’ equity and indicate how profits are utilized. For corporations and public companies, retained earnings can also influence decisions about issuing dividends or repurchasing the company’s stock.
This report is especially important for partnerships and S Corporations, where profits pass through owners and distribution decisions impact both tax planning and capital reserves.
What should you look for in your statement of retained earnings? Pay attention to growth in retained earnings over time, large distributions, and alignment with your financial goals.
If you’re investing heavily, are you seeing a return—such as improved revenue, productivity, or market reach? If not, it may be time to re-evaluate where profits are going.
Keep in mind, this statement can be rolled into the equity section of the balance sheet, but for service businesses reinvesting into growth, it’s often worth it to address it separately, so you can understand how profits are fueling your business.
Additional financial reports you should know
Did you get all that? While those are the core financial statements you need to know about, there are a few more to keep on your radar. These aren’t GAAP-required, but they can provide valuable insights for both day-to-day decision-making and long-term planning.
Some additional reports include:
- Accounts receivable aging report: Shows which customers owe you money and how long their invoices have been outstanding. It helps you stay on top of collections and spot cash flow risks early.
- Budget vs. actual report: Compares your projected income and expenses to what actually happened. This helps identify where you’re overspending, underperforming, or exceeding expectations.
- Profitability by service line or location: Breaks down which parts of your business are most (or least) profitable. Useful for companies with multiple offerings or branches, allowing you to allocate resources strategically.
Each report highlights a few key components that matter to daily decisions. While not part of the core financial statements, these other financial statements can enhance visibility.
How often should you review your financial statements?
How often should you review your financial statements, really? A monthly accounting overview helps you stay on top of your finances, catch potential issues early, and plan ahead.
It helps keep you close to your finances, allows you to catch red flags early, and gives you the information you need to make proactive decisions (instead of just scrambling at tax time).
Adding more financial tasks to your docket might sound intense. Studies show that business owners spend a significant amount of time and money on tax preparation, and many say that bookkeeping and taxes are the most challenging aspects of owning a business.
But don’t worry, we have good news: you don’t need to “do it all,” or go at it alone. You just need to make sure these tasks are being done, whether you’re working with a bookkeeper, a CPA, or using accounting software.
What financial statements reveal about your business’s health
Financial statements are more than just paperwork. They’re powerful tools that help you answer critical questions about your business’s stability, performance, and readiness for growth. They offer a window into your company’s financial health and operations.
For example, they can help you understand the answers to real-world questions like:
- Are we profitable? Your income statement can show whether your business is generating more revenue than it’s spending. A positive net income over time means you’re profitable—but if profits are inconsistent or shrinking, it may be time to revisit your pricing strategy or cost structure. This is where total revenue becomes a key indicator.
- Can we cover our short-term obligations? Your balance sheet holds the answers. By comparing current assets (like cash and receivables) to current liabilities (like bills and loan payments), you’ll know if you can pay what’s due soon.
- Do we have sufficient funds to pay our contractors and employees? The cash flow statement shows whether you have money on hand, instead of just profit on paper. It highlights gaps between billing and actual cash received, which is essential for making payroll, paying vendors, or taking on new projects.
- Are we financially ready to expand? Review your retained earnings statement and cash flow trends. Are profits being reinvested (and are those investments paying off)? Do you have a suitable buffer to cover expansion costs? Financial data provides quantifiable value when tracking results over time, supporting future projections and informed decisions.
Ultimately, when you connect your financial statements to day-to-day operations, you’re able to move forward with confidence—whether you’re adjusting pricing, planning for growth, or simply trying to stay ahead.
Common mistakes small business owners make with financials
Managing your financial statements can be overwhelming, and it’s easy to fall into some common traps that can truly hold you back. Reviewing historical data and spotting historical trends helps you avoid repeating past mistakes.
Here are a few common mistakes many small business owners make:
- Relying only on the bank balance: Your bank account shows cash on hand, but it doesn’t tell the whole story. Without reviewing your financial statements, you might miss out on underlying issues that affect profitability (like outstanding invoices or upcoming bills).
- Not reviewing financials regularly: Waiting until tax season or year-end to look at your numbers means missing opportunities to catch problems early or make proactive decisions. Regular reviews help you stay on top of cash flow, expenses, and growth.
- Ignoring accrual vs. cash basis: Confusing these methods can lead to misinterpreting your financial position. Accrual accounting records income and expenses when they’re earned or incurred (not necessarily when cash changes hands) so it offers a clearer picture of your business’s true health.
- Misclassifying expenses: Incorrectly categorizing costs can distort your reports, affect tax filings, and lead to poor budgeting decisions. Accurate classification helps you understand where your money is going and identify areas for savings. This is where understanding accounting principles and accounting rules matters most.
- Skipping or delaying adjusting entries in accounting: These ensure your books reflect the true timing of income and expenses, especially when using accrual accounting.
- Forgetting to track accrued expenses: These can distort your reports if not accounted for properly.
At Archer Lewis, we specialize not only in being your accounting partner but also in bringing clarity and structure to your financials. Our team helps you avoid these pitfalls by providing services such as accurate bookkeeping, insightful financial reporting, and expert guidance—all with a bespoke, personalized touch.
For many, outsourced accounting for small businesses is the simplest way to stay organized without adding to your workload.
Frequently asked questions
Let’s wrap up with a few questions we hear often from small business owners. If you’re still unsure about what reports you need or how to use them, this section’s for you.
What’s the difference between a bookkeeper, an accountant, and a CPA?
Understanding the differences between bookkeeper vs accountant vs CPA is essential for small business owners. Bookkeepers handle day-to-day transaction recording, accountants interpret financial data and prepare reports, and CPAs (Certified Public Accountants) are licensed professionals who offer strategic advice, audit support, and tax planning.
What’s the difference between cash flow and profit?
Profit is the amount of money your business earns after subtracting expenses (as shown on your income statement). It indicates whether your business is financially successful over a specified period.
Cash flow tracks the actual movement of cash in and out of your business (when the money is received or paid), regardless of when sales are made or expenses are recorded.
Can I skip the retained earnings statement?
The retained earnings statement isn’t always a required separate report, as the information often appears in the equity section of the balance sheet. However, it remains a valuable tool, especially for partnerships, S Corporations, or service businesses that reinvest profits into growth.
Do I need all four reports if I’m a small business?
It depends on your business needs, but generally, having all four key financial statements provides the most complete picture of your financial health. Even for small businesses, these reports serve different purposes.
Some very small or sole-proprietor companies might start with just the first three, but as you grow, the retained earnings statement often becomes more important. Each one plays a role in comprehensive financial statement preparation.
Following accounting standards, such as GAAP or International Financial Reporting Standards, ensures accuracy and compliance with the requirements set by regulatory bodies, like the Securities and Exchange Commission.
Know your numbers, grow your business
Financial statements aren’t just paperwork for accountants or something you glance at during tax season—they’re essential tools for running, growing, and protecting your business. When you understand your income statement, balance sheet, cash flow statement, and retained earnings, you’re better equipped to make smart, confident decisions.
Are financial statements giving you a headache, or a neglected back-burner task? Allow us to assist you. Here at Archer Lewis, we’re more than just an accounting firm: we tackle your financial reports and use those insights to help you grow and succeed.
Whether you’re expanding locations, hiring new team members, launching new products, or simply want to get a better handle on your financial health, let us help you with your financial reporting.
Your financials help provide investors with confidence in your business strategy. Whether tracking total income or managing equity financing, we’re here to help. We’ll help connect your financials to your company’s activities in real time.
Connect with a trusted Archer Lewis advisor today. We’ll help you turn your financial reports into actionable insights.
