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What is a financial statement?
Financial statements are a set of formal written records that show a company's financial activities, position and performance at a specific time. Financial statements include the balance sheet, the income statement and the cash flow statement.
Business owners, creditors, investors and market analysts use these reports to review a company's financial performance and project potential earnings.
What’s the purpose of financial statements?
Unfortunately, it’s not uncommon for small businesses to experience cash flow issues — many of them serious. Financial statements can help you better understand the health of your business and spot potential problems before they become unmanageable.
Let’s consider some common use cases of financial statements.
Reporting to stakeholders
Stakeholders can use financial statements to guide their decision-making around equity investments. For example, after a current partner assesses the statements, they might decide to sell their stake in the company.
Soliciting investors
Potential investors can review financial statements to decide whether they want to become a partner or buy shares in the company. Similarly, anyone considering a merger or takeover bid can use the information to guide their bidding price.
One statement isn't enough to convince investors — they look for quality companies with meticulous records. Any potential investors will want to compare the past few years' financial statements. If you have strong balance sheets and healthy cash flows, venture capitalists will be able to see trends that indicate stability and steady growth.
Securing credit
As banks and other financial institutions don’t have ongoing access to the day-to-day operations of a company, they rely on financial statements to determine a business’ creditworthiness.
Similarly, creditors can use the most recent financial records to restrict or cancel existing credit lines. For example, if a company has a poor year, a bank may close an outstanding loan or deny any applications to extend the company's line of credit.
Fulfilling ASIC requirements
While all companies should keep financial records, certain types of businesses have additional reporting requirements with the Australian Securities and Investments Commission (ASIC). This financial regulator aims to provide accurate financial information for public access.
The following types of companies need to prepare financial statements and lodge reports with ASIC under the Corporations Act 2001:
public companies
large companies limited by guarantee
all registered managed investment schemes
foreign-controlled small proprietary companies
all disclosing entities (e.g. tax agents)
all large proprietary companies that are not disclosing entities
small proprietary companies with 1 or more crowd-sourced funding shareholders at any time during the year.
What are the main types of financial statements?
Income statements
An income statement — also known as a statement of profit and loss - shows the profitability of your business over a specific period, like a year or quarter. This overview includes revenues, expenses, net income and earnings per share.
This report helps business owners identify areas where the company is succeeding or struggling. Also, investors can use a profit and loss statement to project potential returns.
Income statements include two core aspects — revenue and expenses.
Revenue
Business revenue is the top line on an income statement, and it includes all income from:
sales of products and services
secondary earnings, like interest on savings accounts
As secondary revenue and other financial gains are unpredictable sources, it’s best to focus on growing sales revenue from core operations.
Expenses
Business expenses are everything the company spends on running the business. The expenses include:
labour costs
raw materials
operating expenses, such as utilities, rent, administrative costs and the cost of selling and advertising products.
While the cost of raw materials and labour may be negotiable, managing your spending on operating expenses is often tricky. For instance, if the rent for your warehouse increases, you might be unable to find a new space in the right area that’s more affordable.
Balance sheets
A balance sheet is an overview of a company's assets and liabilities as a snapshot in time. The date on the document is usually the end of the reporting period.
A balance sheet has two core aspects — assets and liabilities.
Assets
Assets are all the valuable items your company controls that you expect to yield some financial gain or benefit from in the future. On a balance sheet, assets can include:
cash and cash equivalents
intellectual property (e.g., patents or trademarks)
prepaid expenses
property, plant and equipment (PPE)
Liabilities
Liabilities are the outstanding debts and financial obligations you owe to other parties. On a balance sheet, liabilities include:
accounts payable, including utility bills and supplier invoices
employee-related provisions
shareholder dividends payable
credit card balances
long-term debt, including bond funds, mortgages, or other loans or lease agreements.
The balance sheet shows you how much money you would have at a specific time if you sold all your assets and paid all your debts. This remaining amount is called owner's equity.
Cash flow statements
A cash flow statement is a financial report that shows how cash moves in and out of a company during a specific period. This type of financial statement offers insights into the liquidity of a business by explaining how the company generates cash through operations, investment and financing activities.
Owners and investors can use cash flow statements to gauge the health of business operations. At a glance, you can see how the business gets money and where it spends it.
There are 3 key elements of a cash flow statement:
Operations
Operating activities on a cash flow statement detail all money you earned or spent while running your business. The biggest figure on this statement is usually net income, which is the money you earn from selling your goods and services.
The operating activities section covers incoming cash flow from sales and settled accounts receivable, interest payments and dividends, as well as outgoing cash flow on cost of goods sold (COGS), salaries and wages, accounts payable and more.
Financing
The financing activities on a cash flow statement detail how money moves between a business and its owners, investors and other creditors. This section covers cash you pay to shareholders, public issues of stocks or bonds, stock repurchases, loan repayments, dividends and debt repayments.
Investments
Investing activities on a cash flow statement detail how the company invests for the future. This category includes buying and selling long-term assets like property, plant and equipment (PPE), acquisitions of other businesses, and investments in stock and bonds.
Statement of changes in equity
A statement of change in equity is a financial statement that measures changes in owners’ equity throughout a specific accounting period.
Also called a statement of retained earnings, this summary relates to the balance sheet for the same period. The ending balance on the statement of change in equity is equal to the total equity on the balance sheet.
Here are the key elements of a statement of retained earnings:
Beginning equity is the value of an investor's stake at the end of the last period.
Net income is the proceeds you earn from running the business. Any retained earnings become equity in the company.
Dividends are periodic shareholder payments from company profits. Typically, companies will pay dividends every quarter or semi-annually.
Other activities — such as corrections to previous accounting periods — may cause an increase or decrease in company equity on the financial statement.
How to read financial statements
Although financial statements are useful tools for owners, accountants, creditors and investors, they have some limitations. These statements focus on past performance and rely on accurate reporting. But when it comes to projecting future potential, the statements are open to interpretation.
With that in mind, it's important to read more than one quarterly statement for a company. For investors, it's prudent to read several years of statements to get a better understanding of the company's history.
When reading financial documents, you can compare the most recent data to prior periods to understand changes over time. By evaluating year-on-year changes, you can spot patterns of growth or decline in the company.
To read, understand, and analyse financial statements for your business, follow these steps:
Step 1: Start with the profit and loss statement
Begin by looking at your total revenue at the top, then work down through your expenses to reach your net profit (or loss) at the bottom.
Ask yourself: Is revenue growing compared to last month or last year? Are my profit margins healthy for my industry? Which expense categories are consuming the largest portion of my revenue? This gives you the big picture of your business's profitability.
Step 2: Examine your gross profit margin
Calculate your gross profit margin by dividing gross profit by total revenue, then multiplying by 100. This percentage tells you how much money you're making after direct costs but before operating expenses.
If this margin is shrinking over time, you're either not charging enough or your direct costs are rising. These are both things to work on ASAP.
Step 3: Review the balance sheet for financial health
Look at your assets (what you own) versus your liabilities (what you owe). Your equity — the difference between the two — represents your current true stake in the business.
Check whether your current assets (cash, accounts receivable, inventory) exceed your current liabilities (bills due within 12 months). If they don't, you may struggle to meet short-term obligations.
Step 4: Analyse the cash flow statement
This is where many profitable businesses discover why they're still short on cash. Follow the three sections: operating activities (day-to-day business), investing activities (buying or selling assets), and financing activities (loans and capital). Your operating cash flow should ideally be positive. If you're consistently losing cash from operations, despite showing a profit, you've likely got a problem with receivables, inventory, or expense timing.
Step 5: Compare period over period
A single month's statements tell you very little. Compare this month to last month, and this year to last year. Look for trends: Is revenue climbing steadily or fluctuating wildly? Are certain expenses creeping up? Has your cash position improved or worsened? Trends reveal seasonal customer behaviour and can tell you whether your business is moving in the right direction.
What to watch out for: financial red flags
Certain warning signs in your financial statements can help identify potential pitfalls. Catching these red flags early gives you time to take action to correct issues before problems spiral out of control:
Persistent negative operating cash flow despite reporting profits on your P&L (this gap likely means you're not actually collecting the money you're earning, often due to slow-paying customers or excessive inventory)
Growing gap between accounts receivable and cash receipts (this tells you that if customers are taking longer to pay, your invoice terms may be too generous or your collection process too lax)
Declining gross profit margins (which suggest your pricing isn't keeping pace with costs, or you're discounting too heavily to win business)
Revenue growth without corresponding profit growth (you're probably getting busier but not more profitable, which is often a sign you’re underpricing or have inefficient operations)
Rising debt levels without corresponding growth in assets or revenue (this could tell you that you're borrowing to stay afloat rather than to invest in growth)
Declining owner's equity quarter after quarter (this situation can indicate the business is eroding in value)
Sudden spikes in inventory levels without planned expansion (this suggests poor stock management or declining sales)
Dramatic month-to-month fluctuations in key expense categories that should be relatively stable
If you spot multiple red flags across different statements, schedule time with your accountant or financial advisor to develop a specific action plan. Addressing each concern is wise and shouldn’t be put off for long. Early intervention is almost always cheaper and less painful than dealing with problems that have got out of hand.
How to create financial statements
Typically, an accountant or bookkeeper prepares financial statements. But if you want to create your own reports to assess your business’s financial standing, it’s possible with the help of accounting software.
If you don't use accounting software, here’s how to create a profit and loss statement manually:
1. Start with net sales
The first figure in a profit and loss statement is always net sales. When calculating your total sales for the period, remember to allow for returns, discounts and lost or damaged goods.
2. Calculate the cost of goods sold
While producing your products or supplying your services, you incur costs for materials and labour. Together, these items are the cost of goods sold (COGS).
3. Calculate gross profit
You can figure out your gross profit by subtracting the costs of goods sold from your net sales.
4. Subtract total operating expenses
Aside from COGS, you must consider operating expenses, like sales operations, rent, utilities, travel, wages, management salaries, and more. Gather the costs for each type of operating expense in the period, then add them together to find your total operating expenses.
5. Consider non-operating expenses
A profit and loss statement also includes costs that don’t relate directly to business operations. Non-operating expenses include:
interest
tax expenses.
You can also include costs for "extraordinary gain or loss," such as extensive product loss due to a natural disaster.
6. Create your income statement
As you work out the figures for each element, you can lay out the profit and loss statement. The ideal order is as follows:
net sales
cost of sales
gross profit
operating costs
operating income
interest
taxes.
Some business owners lump all operating expenses together, while others prefer a detailed breakdown by category.
It’s a good idea to put each material or significant item on a separate line for clarity. Also, white space between sections makes it easier to read your financial statement.
7. Calculate net income
The bottom line on a profit and loss statement is net income or net profit. After you lay everything out on the financial statement, you can deduct your total expenses from your gross profit. The remainder is your net income.
Limitations of financial statements
Financial statements are powerful tools, but they're not crystal balls. Understanding what they can't tell you is just as important as knowing what they can.
They're backward-looking, not forward-looking
Financial statements show you what's already happened, like last month's sales, last quarter's expenses, or yesterday's cash balance. They can't predict whether your biggest customer will renew their contract next month, if a competitor will undercut your pricing, or whether a key supplier will go bust.
You need to combine historical data with market knowledge, customer feedback, and industry trends to make your forward-looking decisions.
They don't capture intangible value
Your financial statements will never show the true worth of your brand reputation, customer loyalty, employee expertise, or relationships with suppliers. A business with a brilliant team and devoted customers might look similar on paper to a struggling competitor with high staff turnover and terrible reviews.
These intangible assets often matter more than the numbers suggest, especially when you're considering selling the business or seeking investment.
They reflect accounting conventions, not always economic reality
Financial statements follow accounting rules that don't always match the real world. For example, a piece of equipment might be fully depreciated and show zero value on your balance sheet, yet still be perfectly functional and valuable to your operations. Another example is that inventory recorded at cost might be worth far more (or less) at current market prices.
Always consider economic realities that can have an influence on your business, as well as purely numbers-based and accounting ones.
They ignore external factors and context
Your profit might be down 20% compared to last year, but statements won't tell you this is actually an impressive performance given your industry contracted 40% due to regulatory changes or an influx of competition due to lowered barriers to entry. Or, strong results might look mediocre without knowing you launched a new product line that required significant upfront investment.
Numbers need a narrative added to them to make sense, so don’t forget to factor these things in.
They're only as good as the data entered
The results you get out are only as accurate as what you’ve put in. If you've dropped the ball with categorisation, forgotten to record cash transactions, or haven't reconciled your accounts in months, your financial statements are fiction.
They'll look professional and official, but they're built on a foundation of errors. This is why consistent, accurate bookkeeping matters more than fancy reporting.
They don't account for opportunity cost
Your statements show the money you spent on marketing, for example, but not the revenue you might have earned if you'd invested that money in product development instead.
Opportunity cost — what you give up to make a choice — is invisible in financial statements but crucial to strategic thinking.
Financial statements are essential management tools that every business needs, but they're also just one input into decision-making, not the whole story. Combine them with customer conversations, competitor analysis, market research, and your own intuition about where your industry is heading each quarter.
Generate financial statements with MYOB
While you can prepare a profit and loss statement yourself, there are challenges with creating financial statements. If you don’t have experience in accounting or financial analysis, it’s easy to make mistakes. Even with experience, these evaluations are arduous and time-consuming.
If you’d rather focus your energy on other areas of your business, choose accounting software that'll help you automatically generate financial statements. With financial reporting and insights built into every MYOB plan, you can choose the package that’s right for you.
Get started with the MYOB business management platform today.
Financial statement FAQs
How often should financial statements be prepared?
Most Australian businesses should prepare financial statements monthly to stay on top of their financial position. Monthly statements give you helpful insights to make informed and timely decisions, spot problems early, and adjust your strategy before small issues become major headaches. If you're using cloud accounting software like MYOB, generating monthly statements takes just a few clicks once your accounts are reconciled.
How do the three main financial statements link together?
The three main financial statements — profit and loss, balance sheet, and cash flow statement — are interconnected and tell different parts of the same story. Here's how they fit together:
Your profit and loss statement (P&L) shows whether you made a profit or loss during a period. That net profit (or loss) flows directly into your balance sheet as an increase (or decrease) in assets and liabilities, as well as your owner's equity.
The cash flow statement reconciles your net profit from the P&L with the actual change in your cash position on the balance sheet. Why? Because profit doesn't equal cash. You might show a $50,000 profit, but if customers haven't paid their invoices yet, or you've spent money on inventory, your actual cash might be much lower. The cash flow statement explains these timing differences by showing how profit converts (or doesn't convert) into actual cash in the bank.
Think of it this way: the P&L tells you if you're profitable, the balance sheet gives you an idea of what the business is worth, and the cash flow statement tells you if you can pay your bills.
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