The 3-Statement Foundation
Financial statements tell the complete story of a business. The Income Statement shows performance (profit/loss), the Balance Sheet shows position (assets/liabilities), and the Cash Flow Statement shows liquidity (cash movements). Together, they reveal the financial health of any company.
❌ Common Confusion
"Profit means cash in the bank." This misunderstanding causes 70% of small business failures. Revenue ≠ cash received. Expenses ≠ cash paid out.
✅ Financial Reality
Profitable companies can go bankrupt. Understanding the difference between accrual accounting (Income Statement) and cash accounting (Cash Flow) is crucial for survival and growth.
The 3 Essential Financial Statements
1. Income Statement
"How much money did we make?" Shows revenue, expenses, and profit over a period (month, quarter, year).
The Restaurant Analogy
Think of a restaurant:
• Revenue = Food sales
• COGS = Ingredients cost
• Expenses = Rent, salaries, utilities
• Profit = Money left after all costs
💡 FinTalksNP Insight: The Income Statement uses accrual accounting. Revenue is recorded when earned (not when cash is received). This creates timing differences vs. cash flow.
2. Balance Sheet: The Financial Snapshot
"What do we own and owe at this exact moment?"
Balance Sheet in Simple Terms
3. Cash Flow Statement: Follow the Money
Cash from Operations
Cash generated from main business activities. Starts with net income and adjusts for non-cash items.
Cash from Investing
Cash used for long-term assets (equipment, buildings) or received from selling them.
Cash from Financing
Cash from borrowing/issuing stock or used for repaying debt/paying dividends.
The Cash Flow Bottom Line
💡 Critical Insight: Positive net income ≠ positive cash flow. Companies can be profitable but run out of cash if they don't collect receivables or invest too much in inventory.
How The 3 Statements Connect
The Financial Statement Interplay
The Connection Example: Net Income from Income Statement → Increases Retained Earnings on Balance Sheet → Starting point for Cash from Operations on Cash Flow Statement
Key Financial Ratios Made Easy
Profitability Ratios
Gross Margin: (Revenue − COGS) ÷ Revenue
What's left after direct costs
Net Profit Margin: Net Income ÷ Revenue
What's left after ALL costs
ROE (Return on Equity): Net Income ÷ Equity
How well owners' money is working
Liquidity Ratios
Current Ratio: Current Assets ÷ Current Liabilities
Can we pay short-term bills? (Goal: >1.5)
Quick Ratio: (Cash + Receivables) ÷ Current Liabilities
Can we pay bills without selling inventory?
Cash Ratio: Cash ÷ Current Liabilities
Most conservative liquidity measure
Efficiency Ratios
Inventory Turnover: COGS ÷ Average Inventory
How fast we sell inventory
Receivables Turnover: Revenue ÷ Average Receivables
How fast we collect from customers
Asset Turnover: Revenue ÷ Total Assets
How well we use assets to generate sales
Real-World Example: Coffee Shop Analysis
Cash flow warning: Even with $5,000 monthly profit, if customers pay in 30 days but suppliers demand payment in 15 days, the shop could run out of cash despite being profitable.
Red Flags in Financial Statements
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