Financial Statements: What They Are and

Why They Matter

A Simple Guide to the Balance Sheet, Income Statement, and Cash Flow Statement

Every organization—whether a small shop, a charity, a multinational company, or even a

government department—needs to understand its financial position. Financial statements provide
this information in a structured, standardized way. They help owners, managers, investors,
lenders, and regulators make informed decisions.

This guide explains the three main financial statements, how they work, and why they are
essential.

1. The Balance Sheet (Statement of Financial

Position)
A balance sheet shows a company’s financial position at a specific date.
It tells you what the business owns, what it owes, and the amount invested by owners.

Balance Sheet Formula

Assets = Equity + Liabilities

Assets

Assets are resources owned by the business. Two main types:

a. Current Assets

Used or converted into cash within 1 year. Examples:

• Cash
• Bank balance
• Inventory
• Trade receivables
• Short-term investments

b. Non-Current Assets

Last longer than a year. Examples:

 • Machinery
• Buildings
• Furniture
• Long-term investments

Liabilities

What the business owes.

a. Current Liabilities (due within a year)

• Trade payables
• Short-term loans
• Accrued expenses

b. Non-Current Liabilities (due after 1 year)

• Long-term loans
• Bonds payable

Equity

The owner’s interest in the business.

Includes:

• Capital invested
• Retained earnings (profits kept in the business)

Why the Balance Sheet Matters

• Shows liquidity and financial strength

• Helps assess solvency and debt levels
• Used by banks to decide on loans
• Helps investors check stability

2. The Income Statement (Profit or Loss

Statement)
The income statement shows performance over a period (e.g., 1 year).
It reports revenue, expenses, and profit or loss.

Basic Structure
 1. Revenue (Sales)
2. Cost of Sales
3. Gross Profit
4. Operating Expenses
o Salaries
o Rent
o Utilities
o Marketing
5. Operating Profit
6. Finance Costs (Interest)
7. Net Profit Before Tax
8. Tax
9. Net Profit After Tax

Why the Income Statement Matters

• Shows whether a business is profitable

• Helps managers control expenses
• Allows comparison with past performance
• Helps investors judge growth potential

Example

If a shop sells Rs. 500,000 worth of goods but spends Rs. 350,000 on expenses, its profit is Rs.
150,000. This one number tells investors a lot about efficiency and success.

3. The Cash Flow Statement

Profit does not always mean cash. A company can be profitable yet run out of cash to pay bills.
The cash flow statement explains the movement of cash in three categories:

1. Operating Activities

Cash related to daily business:

• Cash received from customers

• Cash paid to suppliers
• Salaries
• Utilities

This section shows if the business can generate cash from its normal activities.

2. Investing Activities
Cash from buying or selling long-term assets:

• Purchase of equipment
• Sale of machinery
• Investment in other companies

Negative cash flow here is not always bad—it may mean the business is expanding.

3. Financing Activities

Cash from owners and lenders:

• New loans taken

• Loan repayments
• Issue of shares
• Dividend payments

Why the Cash Flow Statement Matters

• Shows actual liquidity

• Helps predict financial troubles
• Important for banks to evaluate repayment ability
• Helps managers decide when to invest or borrow

How These Three Statements Work Together

The statements are connected:

• Net profit from the income statement increases equity on the balance sheet.
• Cash from operating activities appears as a current asset on the balance sheet.
• Buying equipment reduces cash on the cash flow statement and increases non-current
assets.
• Taking a loan increases cash and increases liabilities.

Together, they give a complete picture of:

• Performance
• Financial health
• Cash stability
• Long-term sustainability
Conclusion
Financial statements are the language of business. By learning to read the balance sheet, income
statement, and cash flow statement, you gain the ability to understand how any organization
functions financially.

Whether you're an investor, a business student, or running your own startup, mastering these
three statements will help you make smarter, more confident decisions.