Here’s the common understanding of a company’s financial statements:
Income statement — the place where I check my revenue and net profit lines, everything in-between has meaning too, so I’m told
Balance sheet — cash, receivables, and loans… and what’s this “prepaid expenses” line that hasn’t changed in a few years?
Cash flow — wait, there’s a third financial statement?
To get maximum value out of financial tools like scorecards and budgets, we need: (1) best practices during the construction phase of the financial statements (bookkeeping); and (2) a baseline understanding of how the financials work (how to read them).
Let’s get to know these statements a bit better so we can properly analyze them…
Ground Rules
A few important considerations when using “your numbers.”
First, there is no single statement that’s better than the others. You’re probably accustomed to only looking at your P&L, but that gives you only one view of your business. (The Grand Canyon is pretty cool at both the rim and down on the floor.)
Second, all three statements work together. If something happens in one statement, it’s likely having an impact elsewhere on another statement (buying inventory adds to the balance sheet while reducing cash flow, selling inventory adds revenue and COGS on the income statement while reducing inventory on the balance sheet, etc.).
Last, each statement answers a different question about the company. The income statement tells us earnings power. The balance sheet tells us staying power / financial position. And the cash flow statement tells the sources & uses of cash.
Let’s start with the income statement or profit & loss (P&L)…
