The Three Essential Financial Statements: Your Business's Financial GPS

Understanding your business's financial health requires more than just a quick glance at your bank balance. To truly grasp where your company stands, where it's been, and where it's going, you need to look at three core financial statements. This is your business's financial GPS, providing different but equally vital perspectives. 

1. The Profit & Loss (P&L) Statement (also known as the Income Statement) 

This is often the most familiar statement for business owners, and for good reasons. It tells your company's performance over a period of time, typically a month, quarter, or year. 

What it shows 

• Revenue: What you sold 
• Expenses: What you spent to generate that revenue. 
• Profit (or Loss): What you earned after all expenses. 

How to Calculate Profit when Using a P&L Statement  

A typical P&L starts with your total sales, and subtracts things like promotions and discounts (known as trade spend) to get to net revenue. Then, you deduct the cost of goods sold (COGS), the direct costs of producing your products or services, to arrive at gross profit. After that, operating expenses like sales, marketing, and general administrative costs are subtracted to reveal your operating income, often highlighted by EBITDA (earnings before interest, taxes, depreciation, and amortization), and finally, your net profit. 

Understanding Your Gross Margin 

For early-stage founders, understanding your gross margin is critically important. It's a key part of your unit economics and shows how much profit you make on each sale before overhead. 

How It's Calculated:  

• (Net Revenue - Cost of Goods Sold) / Net RevenueComponents: 
• Net Revenue: Your total receipts from sales minus any trade spend. Trade spend can include promotional discounts, slotting fees (charged by new retailers), and returns/allowances (deductions for things like incomplete deliveries). 
• Cost of Goods Sold (COGS): If you use co-packers, this is primarily their cost per unit plus any tolling fees. For self-manufacturers, it includes raw materials, packaging, labor, waste, yield loss, shrinkage, and inbound freight. 

Your gross margin tells you a lot about the inherent profitability of your core product or service before considering broader operational costs. 

2. The Balance Sheet 

While the P&L shows revenue and profitability performance over time, the balance sheet provides a snapshot of your company's financial position at a specific moment, usually at the end of a month or quarter. It's built on the fundamental accounting equation: Assets = Liabilities + Equity. 

What it shows 

• Assets: What your company owns. This includes cash on hand, inventory, and accounts receivable (AR) – money owed to you by customers. 
• Liabilities: What your company owes to others. This includes accounts payable (AP) – money you owe to vendors, and any outstanding debts. 

• Equity: The owners' stake in the company. This includes retained earnings and initial investments. 

Understanding Asset/Liability Movement: 

A key concept with the balance sheet is how changes in assets and liabilities affect your cash. 

Increasing Assets:  

Increasing assets, like buying more inventory or having money owed to you, generally uses cash. If you buy a lot of inventory, that cash is now tied up in goods. If customers owe you a lot of money (high AR), that cash isn't in your bank account yet. 

Understanding Liquidity 

It is important to understand if your current assets are enough to satisfy your current liabilities.  Do you have enough cash on hand or coming in to satisfy paying the vendors and your debt payments you owe? 

Note on Convertible Notes and SAFEs 

These are common financing instruments for startups. Convertible notes are classified as a liability because they are a debt instrument that bears interest and has a due date. Simple agreements for future equity (SAFEs) are trickier because they don't have a due date. While some SAFEs have language that might give them ‘equity type’ benefits, in most cases, SAFEs should be treated as a liability until they are converted to equity. 

3. The Statement of Cash Flows 

This statement is often the most challenging for people to grasp, but it's arguably the most important for understanding your company's true liquidity. It tracks the actual cash movements over a period of time, reconciling your net income from the P&L with the changes in your balance sheet to show precisely where your cash came from and where it went. 

What it shows 

• Operating Activities: Cash generated or used by your core business operations. 
• Investing Activities: Cash used to buy or sell assets (like property or equipment). 
• Financing Activities: Cash from debt, equity, or paying dividends. 

The Critical Insight: Profit Does Not Equal Cash 

A common misconception is that if your P&L shows a profit, then you have plenty of cash. This is often not the case. As a business grows, you might be very profitable on paper, but your cash can be tied up in: 

• Increasing Inventory: You need to buy more stock to meet growing demand. 
• Accounts Receivable: Customers owe you money, but they haven't paid yet. 
• Pre-payments: You might pay for services or goods in advance. 

As Michael Dell famously put it, "We were always focused on our profit and loss statement. But cash flow was not a regularly discussed topic. It was as if we were driving along watching the speedometer, watching your revenues, when in fact they were running out of gas." The "gas" in your race car is your cash. 

This highlights the importance of the cash conversion cycle – the time it takes to convert your investment in inventory and other resources back into cash from sales. 

To get a comprehensive, accurate, and actionable picture of your business’s financial health, you need all three financial statements. Failure to do so could leave you with inaccurate numbers and misinformed decision-making, ultimately harming your business. At EisnerAmper, our trusted team has decades of experience helping companies better understand their financial health and opportunities for future strategic growth and profit. Learn how we can help you by contacting us below.