Running a business is much easier when you know what your financial reports are telling you. Three of the most important documents are the balance sheet, the profit and loss account (sometimes called an income statement) and cash flow statement. Think of these as your business’s health check-ups.

What is a profit and loss account?

A profit and loss account (P&L) measures how much money your business made and spent over a period of time (usually a year). It shows whether you ran at a profit or a loss by:

• Totaling your income (or revenue) from products or services.
• Deducting expenses of running the business (materials, wages, rent, utilities, marketing).
• Which leaves the Profit (or loss).

The P&L tells you if your business is making money and is used by the IRS to calculate tax to pay. Types of expenses on an income statement.

Gross profit

Also called gross margin, which is what’s left over after any direct costs (like inventory or raw materials). Service businesses without any physical ‘product’, will have a 100% margin. The higher your gross profit, the more money your business has to cover operating expenses and earn net profit.

Operating expenses

Also called operating costs or overheads, this is the cost of running your business, including rent, utilities, wages, marketing, tax and general overhead. If you have assets being depreciated, it will also be added here.  

Operating profit or EBIT (earnings before paying interest and tax)

Is the money you make from carrying out your core business, after operating expenses have been paid. It paints a picture of how good your business operations are at turning earnings into profit.

Net profit 

Is the profit after income tax.

What is a balance sheet?

A balance sheet is a snapshot of your business’s financial position at a particular time, usually on the last day of the financial year (though you can get monthly reports, primarily via your accounting software). 

It’s called ‘balance’ as the equation used is assets = liabilities + equity.

If you add up all your assets, they will equal (or balance with) your liabilities and equity.

Assets 

Assets help you do business, usually equipment, machinery, but also cash in the bank, and at the end of the year, who owes you money from receivables. Your balance sheet shows what each asset is worth (if an asset, it’s the depreciated value not the purchase value).

You may also have intellectual property, prepaid expenses or investments.

Liabilities 

This is money you owe, or will have to pay in the future, and often split into current liabilities owed in the next 12 months (for example income tax, loans or overdrafts due within 12 months, customer pre-paid orders or money you are been paid in advance. And non-current liabilities which is money you’ll have to pay out over a number of years, including loans, mortgages, hire purchase of vehicles.

Equity 

This measures the accumulated profit in your business, including money from you or an investor. It’s made up of previous retained earnings, plus this year’s net income (hopefully profit but it could be a loss which reduces equity).  

Positive equity means your assets are worth more than your liabilities. Negative equity means your liabilities outweigh your assets and the business is on unstable ground.

What is a cash flow statement?

A cash flow statement is a summary of your business’s cash transactions over a certain time period. It’s the money coming in and going out of your trading account with insights into patterns and or problems.

Cash flow from operations

This shows the comings and goings of cash related to your core business. Cash in is from customers, while cash out covers suppliers, inventory, staff, and all operating expenses.

If your net operating cash flow falls below zero, you’re not earning enough to cover costs in your day-to-day business. 

Cash flows from investing or finance

This shows the flow of cash in the business that’s not part of trading, but can impact how much money you have in the bank. If you sell land, receive interest or dividends, or borrow money, it’s all cash coming in, but not part of the business day-to-day activities. Similarly, if you repay any long-term debt or buy land, it’s money going out. 

Net change in cash

There will be a difference between your opening and closing cash balances (hopefully higher than lower). It’s a good idea to check why. 

If the closing balance is negative, your business isn’t covering costs solely with money made from day-to-day operations over this time period. To stay in business you might have to borrow or readjust the structure of your business. In some cases, businesses in a growth phase may be experiencing a significant cash burn, but they have plenty of cash from investors until the business breaks even. Software companies who are focused on scaling are a good example. 

Resources

For more information on how to get started with your business, visit this page or make an appointment with one our expert business bankers. 

FAQs

Q: Why do I need both reports?

A: The profit and loss tells the trading story of the last 12 months, and if you made a profit or loss. The balance sheet tells you about the business since it started, where you stand at a particular date.

Q: How often should I look at these reports?

A: Monthly is best for most businesses. Waiting until year-end is risky because problems may go unnoticed.

Q: What if my P&L shows a profit but I have no cash?

A: Profit doesn’t equal cash. Your profit might be tied up in unpaid invoices or stock. That’s why you also need a cash flow statement (a third key report).

Q: Who prepares these reports?

A: Accounting software can generate them automatically, but an accountant or bookkeeper should help interpret them and check accuracy.

Q: What should I watch for in the balance sheet?

A: High debt compared to assets, shrinking equity, or overdue liabilities can signal problems.

Q: What should I watch for in the P&L?

A: Falling margins, rising costs without matching sales growth, or large one-off expenses.

Q: How do these reports help with funding?

A: Banks and investors look closely at both to judge how strong and profitable your business is before approving loans or investment.