Reading Your Financial Statements: P&L, Balance Sheet, and Cash Flow

Three Statements. Three Stories.

Your business generates three financial statements, and each one tells a different story. Most owners glance at revenue and call it a day. That is like checking only your speedometer while your engine temperature gauge is redlining.

Here is how to read all three — and what they actually tell you.

The Profit and Loss Statement (P&L)

Also called the income statement. This is the one most owners look at because it answers the most obvious question: "Am I making money?"

The Structure

• Revenue (Top Line): Total money earned from sales. Not collected — earned.
• Cost of Goods Sold (COGS): Direct costs to deliver your product or service. Materials, subcontractor labor, direct labor.
• Gross Profit: Revenue minus COGS. This tells you how much you keep before overhead.
• Operating Expenses: Rent, salaries, insurance, marketing, software, utilities.
• Operating Income: Gross profit minus operating expenses. This is your business's actual performance.
• Net Income (Bottom Line): After interest, taxes, and any one-time items.

What to Watch For

• Gross margin dropping? Your direct costs are eating into profit. Either your pricing is off or your costs are rising.
• Revenue up but net income flat? You are growing but not profitably. Expenses are scaling faster than revenue.
• One-time items inflating or deflating the picture? Separate the noise from the signal.

The Balance Sheet

The balance sheet is a snapshot of what your business owns, what it owes, and what is left over. It follows one formula:

Assets = Liabilities + Owner's Equity

The Structure

Assets (What You Own)

• Current assets: Cash, accounts receivable, inventory
• Fixed assets: Equipment, vehicles, property
• Other assets: Deposits, intellectual property

Liabilities (What You Owe)

• Current liabilities: Accounts payable, credit cards, short-term loans, taxes owed
• Long-term liabilities: Mortgages, equipment loans, SBA loans

Owner's Equity

• What is left after subtracting liabilities from assets. This is your ownership stake in the business.

What to Watch For

• Current ratio (current assets / current liabilities): Below 1.0 means you may not be able to cover short-term obligations. That is a liquidity crisis waiting to happen.
• Accounts receivable growing faster than revenue? People are not paying you fast enough.
• Debt-to-equity ratio climbing? You are leveraging more debt to run the business, which increases risk.

The Cash Flow Statement

This is the statement most owners ignore and the one that matters most. The cash flow statement shows you where cash actually came from and where it went.

A business can be profitable on paper and still run out of cash. This statement tells you if that is happening.

The Three Sections

Operating Activities Cash generated or consumed by day-to-day business operations. This starts with net income and adjusts for non-cash items like depreciation and changes in working capital (receivables, payables, inventory).

Investing Activities Cash spent on or received from long-term assets. Buying equipment is a cash outflow. Selling a vehicle is a cash inflow.

Financing Activities Cash from loans, investor contributions, or owner draws. Taking a loan is an inflow. Paying it down is an outflow. Distributing profits to owners is an outflow.

What to Watch For

• Operating cash flow negative while P&L shows profit? Your receivables are piling up or you are carrying too much inventory.
• Constantly relying on financing activities to stay afloat? You are using debt or owner injections to cover operating shortfalls. That is not sustainable.
• Free cash flow (operating cash flow minus capital expenditures) positive? That is the real money available to grow, pay down debt, or pay yourself.

How These Three Work Together

The P&L tells you: "Are we profitable?" The balance sheet tells you: "Are we solvent?" The cash flow statement tells you: "Can we survive?"

You need all three. A profitable business with no cash goes under. A cash-rich business with mounting liabilities is borrowing time. A business with strong cash flow but shrinking margins is heading for trouble.

How Often Should You Review Them?

• P&L: Monthly, at minimum. Compare to prior month and same month last year.
• Balance Sheet: Monthly. Watch current ratio, receivables aging, and debt levels.
• Cash Flow: Weekly if cash is tight. Monthly if it is stable.

Stop Outsourcing Your Understanding

Your accountant prepares these statements. Your job is to read them, question them, and act on them. You do not need to be a CPA. You need to know what the numbers are telling you and whether you are comfortable with the trajectory.

If your accountant cannot explain your financials in plain language, get a new accountant.