▶️ Video: What Are Financial Statements?

Many entrepreneurs struggle with financial statements — both creating them and understanding what they mean. Don’t worry if that’s you too. The goal is not just to “get them done,” but to use them as tools to make smarter, more strategic decisions that help your business grow.

Before diving into the three main financial statements, remember what we just covered about bookkeeping. Financial statements are part of that process — they help you see the big picture of your business after you’ve been tracking your daily numbers.

There are three key questions every entrepreneur should be able to answer:

1. Am I making money?
This question is answered by your income statement, which shows whether your business made a profit over a specific period — for example, this month or this year.

2. Can I pay my bills?
This is where your cash flow statement comes in. It tells you if you’ll have enough cash to cover expenses like payroll, rent, or supplies when they’re due.

3. What’s my business worth?
Your balance sheet helps answer this. It lists what your business owns (assets) and what it owes (liabilities). The difference between the two is called owner’s equity — a simple way to estimate your business’s value.

It’s really that straightforward: three questions, three statements.

And here’s an easy way to think about each one:

• Income statement: revenues (sales) minus expenses = income (profit).

• Cash flow statement: cash in minus cash out = net cash.

• Balance sheet: assets (what you own) minus liabilities (what you owe) = owner’s equity.

These statements are not just paperwork — they’re powerful tools to help you understand your business, plan ahead, and make confident decisions.

When you look at your income statement, you’re basically seeing how much money your business made and how much it spent over a period of time. It starts with your total sales or revenues — everything your business earned — and then subtracts your expenses.

Your expenses are divided into two main categories:

• Cost of Goods Sold (COGS): These are the costs directly related to producing, packing, and delivering your product or service.

• General, Selling, and Administrative (GSA) Expenses: These are your operating costs, like salaries, rent, insurance, and marketing.

Here’s the simple logic of the income statement:

1. Start with your revenues (sales).

2. Subtract your Cost of Goods Sold — what it costs to make and deliver what you sell.

   • The result is your Gross Margin (also called Gross Income).

3. Subtract your operating expenses (your GSA costs).

4. Then subtract any interest you owe and income taxes.

   • The final result is your Net Income, or Net Profit — the money your business actually earned.

In short: Revenue → COGS → Operating Expenses → Interest → Taxes → Net Income.

Below, you’ll see a simple example of an income statement organized by month. You can also prepare one weekly if your business has a lot of transactions. In this example, the numbers are in thousands of dollars. You’ll notice there’s no expense for materials or labor in the first month — that’s because no production or orders happened. Numbers in parentheses mean the business had a loss for that month.

In this case, the business made its first profit in March, but experienced losses later in the year as sales declined — showing that the business is affected by seasonal changes. For the entire year, the business ended with a net income of $78,000.

Sometimes, you’ll also see an expense called depreciation on an income statement. This one can be confusing because it shows up as an expense even though no money is actually being spent at that time. Depreciation simply means that an asset — like a computer, a machine, or a truck — loses value over time as it’s used.

For example, let’s say you buy a truck for $50,000. Over time, it wears out and becomes less valuable. Tax rules let you “spread out” the cost of that truck over several years — this is called depreciation. Using the simplest method, called straight-line depreciation, you divide the cost evenly across the truck’s useful life.

So if the truck’s useful life is five years, you would record $10,000 in depreciation each year ($50,000 ÷ 5). This reduces your taxable income each year — lowering how much tax you owe — while recognizing that the truck is gradually losing value.

📝 Template: Simple Income Statement Example

▶️Video: Managing Income or Profit

For early-stage entrepreneurs, the cash flow statement is often the most important of all the financial statements. It answers a simple but critical question:
Do I have enough cash in the bank to pay my bills?

Cash flow is the lifeblood of your business. The cash flow statement tracks all the cash coming in and all the cash going out of your business — not just your sales and expenses.

Here’s how it works:

• Cash coming in includes sales, loans, and any money you invest personally in your business.

• Cash going out includes everything you pay for — materials, salaries, rent, utilities, loan payments, and more. (Keep in mind that your income statement only includes the interest part of a loan payment as an expense, but your cash flow statement includes both the principal and the interest because both involve cash leaving your business.)

Below is an example showing how this plays out month by month. In this sample business:

• Month 1 (January): The business starts with no cash but takes out a $300,000 loan, and the entrepreneur adds $20,000 of personal funds (called equity paid in). That’s a total of $320,000 in cash coming in. Since no production or sales happened yet, the business didn’t spend on materials or labor, but it did spend $61,000 on salaries, rent, marketing, and startup costs.

  • That means the month ends with $259,000 in cash, which becomes the starting balance for February.

• Month 2 (February): No new cash comes in, but operating costs continue — about $104,000 in total. The cash balance drops to $155,000.

• Month 3 (March): The business finally begins selling, bringing in $100,000 in cash, but spending remains higher, reducing the cash balance to $128,000.

• Over the following months, cash balances go up and down depending on sales — showing that sales often have seasonal patterns. By the end of the year, the business ends with $250,000 in cash.

This example shows another common reality: the faster your business grows, the more cash you’ll need. It might sound backward, but growth actually uses up cash — not just generates it. As your business expands, you’ll spend more on space, equipment, materials, and employees before the extra sales come in. That’s why many fast-growing businesses find themselves short on cash even when they look successful on paper.

The bottom line: Cash is king. Managing cash flow is one of the most important things you can do as an entrepreneur.

Start by keeping your cash flow statement up to date — it helps you plan ahead and avoid surprises. If possible, use your business bank account to track all transactions electronically. This makes your bank statement a great tool (almost like a built-in cash flow report) for understanding where your money is coming from and where it’s going.

📝 Template: Simple Cash Flow Example

🔍 Guide: Cashflow Projections Guide

▶️ Video

Many entrepreneurs find the balance sheet to be the most confusing of the three financial statements. Part of the reason is that it’s harder to track if you’re using a single-entry bookkeeping system, which doesn’t automatically show how your assets and liabilities change over time.

The balance sheet shows your business’s financial position at a specific moment in time — what you own, what you owe, and what your business is worth. It’s made up of three main parts:

• Assets: What your business owns that has value — things like cash, accounts receivable (money customers owe you), inventory, buildings, equipment, and vehicles.

• Liabilities: What your business owes — including bills due soon (accounts payable), short-term loans, or long-term debts.

• Owner’s Equity: The difference between assets and liabilities — this represents the value of your business. It’s also sometimes called net worth.

Here’s the key formula that keeps it all together:

Assets = Liabilities + Owner’s Equity

Or said another way:

What I own – What I owe = What my business is worth.

That’s why it’s called a balance sheet — both sides must always be equal or “in balance.”

On the balance sheet, assets are usually listed on the left, and liabilities plus owner’s equity are on the right. Assets are organized by how quickly they can be turned into cash (called liquidity). So:

1. Cash comes first,

2. then accounts receivable (money customers owe you),

3. then inventory,

4. followed by equipment, vehicles, and property.

Liabilities are listed by how soon they’re due — short-term first (like bills or short-term loans), then long-term debts.

Owner’s equity comes from two sources:

• Equity paid in: The money you or other owners have personally invested in the business.

• Retained earnings: The profits your business has made and kept (reinvested) instead of paying out.

Here’s an example from the same business used in our earlier income and cash flow statements:

• Assets: $413,000 total — listed from most to least liquid.

• Liabilities: $240,000 — including $15,000 owed to suppliers, a $60,000 short-term loan, and a $165,000 long-term loan.

• Owner’s Equity: $98,000 — made up of $20,000 that the entrepreneur invested and $78,000 in profits that were reinvested into the business (the same profit figure shown on the income statement).

When you add it all up, both sides equal $413,000 — which shows that everything balances perfectly.

For most early-stage businesses, the balance sheet will look pretty simple. In the beginning, your business might not have many assets — maybe just some equipment, tools, or cash in the bank. Your liabilities, on the other hand, might include things like money you owe to suppliers or landlords (accounts payable) and any loans you’ve taken out.

If you’re leasing equipment, those payments also count as liabilities. And remember — sometimes there are personal debts that don’t show up in your business records but still affect your finances. It’s important to keep personal and business debts separate so you have a clear picture of your business’s true financial position.

Your owner’s equity is what’s left over after subtracting liabilities from assets — it’s your share of the business. In most small businesses, the entrepreneur is the sole owner, though sometimes ownership is shared between spouses or partners.

As your business grows, it’s a good practice to set a goal to reinvest part of your profits back into the business each year. This strengthens your company’s finances, helps you handle unexpected challenges, and builds long-term value.

Because the balance sheet follows the equation:

Assets = Liabilities + Owner’s Equity

it shows how your business is financed — either through borrowed money (liabilities) or through your own investment and profits (owner’s equity).

Here’s how owner’s equity changes over time:

• It increases when you invest more of your own money or when your business makes a profit that you keep in the company.

• It decreases when you take money out of the business or when the business experiences losses.

Finally, remember that your balance sheet gives a conservative estimate of what your business is worth — basically, what would be left if you sold all your assets and paid off all your debts. Banks like this conservative view, but in reality, your business might be worth more when you consider things like brand reputation, loyal customers, and future earning potential.

📝 Template: Balance Sheet Example

Cash flow is the difference between the amount of money coming into the business each month and the amount of money going out of the business to pay for things. A positive cash flow is the point where more money is coming in than you are spending each month. While most of our entrepreneurs are able to keep their initial costs relatively low, keep in mind that starting a business costs money and it is important not to underestimate that amount.

When you first start a business, you are usually spending more money than money coming in. So you operate at a loss or deficit until you attract enough customers and make enough sales to cover all your costs. This means you need to have enough savings or cash on hand to get you to the point that the business is self-sustaining or is generating excess cash (which can be reinvested in the business or taken out to support you and your family). And even after you get to this point, you will always want to have some sort of safety margin in terms of excess cash on hand for unexpected developments.

You should be thinking about three categories of costs:

1. One-time start-up costs: expenses that you usually pay one time in order to get the business launched, such as registering the business, paying for licenses or permits, legal costs, equipment/machines you need to buy prior to starting operations, money spent on research, technology development, copyrights, patents, trademarks, creating a website, developing a logo, buying office furniture, having a grand opening. Think of any costs you spend to get to the point that you can make your first sale.

2. Monthly operating costs necessary to operate the business on an ongoing basis (sometimes called overhead): this would include ongoing monthly costs for rent if you have an office or store or facility, business insurance, utilities, employees who receive a salary rather than hourly pay, marketing, office supplies, security systems, and fees for professional services.

3. Monthly operating costs necessary to make and sell your product: this would be the ongoing monthly costs to pay for hourly employees, raw materials, ingredients, inventory, packaging, and delivery costs. These will vary directly with how many sales you make, and so are driven by your forecast of monthly sales.

The beginning point is to make a list of all the one-time start-up costs. We have listed some of the most common ones in bullet point #1 above. Next, estimate your overhead costs, or other ongoing costs of keeping the business going each month, such as rent and insurance (we also refer to many of these as fixed costs). Beyond this, you need to consider a) your costs and margins related to making and selling the product or service; and b) your projected level of sales in each of the first twelve months of your business.

To determine how much money it will require to start your business, it may be helpful to create a chart like the following. Here, we are considering the first twelve months of the business (see table attached here).

In this example, you would need the $9,820 to cover your start-up costs, but you also have to have enough money to cover your losses in the first months of operations. In month 1 of operations, you are selling 40 units. You are making $12 in margin on each unit sold (after covering your variable cost, or cost of making and selling the product or service). But your overhead or fixed costs in month 1 are $2,020. With 40 units sold, you would only have $480 left over to cover the overhead. So, you are short by $1,540. In month 2, you anticipate selling 85 units, and continuing to earn $12 in margin on each item sold, for a total of $1020, but overhead continues to be $2,020, and so in the second month you are short by $1,000. In month three, estimated sales are 130, the margin continues to $12 per unit, and so your total revenue coming in is $1,560. This leaves you cash short on covering costs by $460. In month four, you expect to sell 170 units, with a margin per unit of $12, for a total cash inflow of $2040, and overhead is $2,020, which means more cash is coming in than is going out.

So, you would have needed $9,820 + $1,540 + $1,000 + $460 = $12,820 to start the business and have enough money on hand to get to a positive cash flow. This number assumes you achieve the level of sales you expect to have each month and that no unexpected expenses occur. So having a safety margin would probably be a good idea.

Here is a good source when you are thinking about what your startup costs might be: https://www.nerdwallet.com/article/small-business/business-startup-costs

It is vital that you separate your personal expenses from your business expenses. We strongly encourage you to be disciplined in not trying to combine the two. Having a business bank account that is separate from your personal bank account is critical, but so too is carefully distinguishing which expenses are personal and business-related, and keeping precise records. At the same time, many of our entrepreneurs depend on the business to help cover their family living expenses.

Your goal should be to put as much money back into the business each month as you can, particularly in the early months. However, the practical reality is that sometimes you need to withdraw money from the business to help with personal expenses. Do not do this haphazardly—try to plan for it. Estimate the amount you need to take out each month. Be conservative, taking as little out as you can.

A number of entrepreneurs opt to not pay themselves anything for their work in the business, and instead to periodically withdraw money from the business to pay some bills. It would be better if you did pay yourself a regular hourly rate or monthly salary, and treat this as a business expense. It will better enable you to determine your operating costs and set your prices at an appropriate level.

If you know that you need to take money out of the business on a regular basis, then it will increase how much you need to sell in order to both breakeven (see STEP 15) and take this amount out. Here is a simple way to calculate how much you have to sell. Let’s assume you need to take $1,500 out of the business each month to help cover some of your personal expenses. Then you just add this amount to the numerator of the breakeven formula:

Required Level of Sales= (Total Fixed Costs + $1500)/Contribution Margin