How to Read Financial Statements & Analyze Like a Pro

If you want to be more health conscious, you read nutrition labels. If you want to improve your fantasy football team, you read player stats. If you want to know your money’s movement in and out of your business—and we really hope you want to know that—you read financial statements.

The thing is, if you didn't graduate with a finance degree, the idea of trying to make sense of these documents can be borderline terrifying. But there’s no need to fear that email with the “monthly budgets” subject line. The task isn’t that complicated—once you know what you’re looking at.

Keep scrolling to learn how to read financial statements and know where your business’ money is.

What are financial statements?

Financial statements are reports that show where your money came from, where it went, and where it currently is. You’ll typically prepare these statements monthly, quarterly, or yearly, depending on the financial data you want to look at.

If your small business is reporting to agencies within the U.S., your financial statements are governed by the Generally Accepted Accounting Principles (GAAP). Your accounting team must prepare, present, and report them in accordance with those rules. 

Three types of financial statements

There are three main types of financial statements that every business will use. Each serves its own purpose and outlines the specific financial activities of your company.

• Balance sheets — Gives you a high-level view of your financial position at a specific point in time. 
• Income statements — Allows you to gauge your profitability and see how your financial activities impact your business.
• Cash flow statements — Tells you how your business operations are running and gives you a better understanding of how you’re spending your money and where it’s going.

These statements are vital for your financial operations regardless of whether or not you’re looking to turn a profit. Still, they will slightly differ if you’re using them to run a nonprofit business.

Nonprofit financial statements vs. profit 

The main differences you’ll see in for-profit and nonprofit financial statements are the names of the documents and how they’re used.

When nonprofits refer to financial statements:

• A balance sheet becomes a statement of financial position
• An income statement becomes a statement of activities
• A cash flow statement becomes a statement of cash flow

Nonprofit organizations also use these three financial statements more for donors, internal auditors, and government agencies to demonstrate that they are:

• Running well as a charitable organization
• Using raised funds to support the organization’s mission
• Complying with legal and tax requirements

From basic understanding to analysis

Here’s the thing. It’s one thing to sit with your financial documents and know they are, in fact, an income statement or a balance sheet. Properly reading and making sense of those documents—especially if you lack accounting or finance experience—is something else entirely. 

You don’t need to give yourself a headache trying to sort through countless lines of numbers and categories. Let’s look at how you can easily read financial statements and know exactly where your money is.

Reading balance sheets

A balance sheet breaks down how much money you have, how much debt you owe, and how much money you’ve put into the business. When you prepare these documents, they’ll show the financial data from a specific point in time— for example, comparing December 2023 to December 2024. 

Components of a balance sheet

​​Looking at your balance sheet, you’ll see three main sections. Each section will include subcategories that combine to give you the total dollar amount for the larger category.

• Assets — Your assets are how much value you have readily available. This can include your cash, accounts receivable, equipment, inventory, and investments.
• Liabilities — Your liabilities are how much money you owe. This can include your accounts payable, accrued expenses, long-term debt, and wages payable.
• Equity — Your equity is how much you’ve invested into your business. This can include your capital, retained earnings (your profits), and owner’s draw (the money you take out as an owner).

Once you have those figures in front of you, there are a few ways you can make sense of the numbers.

Analyzing balance sheets

As the name implies, you always want your balance sheets to balance. Your assets, liabilities, and equity should equal—or at least be very close in amounts. 

A few equations can help you figure out if you’re in a good place.

• Current ratio — This shows how quickly you can convert your assets to cash. To calculate this, take your assets and divide them by your liabilities. The higher the ratio (2:1, 3:1, etc.), the more easily you can cover your liabilities. 
• Quick ratio — This shows how easily you can pay off your debts using high-value assets. To calculate this, add up your cash (and equivalents), your marketable security, and accounts receivable and divide that total by your liabilities. Ideally, you’ll want a 1:1 ratio.
• Debt-to-equity ratio — This shows how much debt you have compared to how much you’ve invested in the business. Simply divide your total debt by your owner/shareholder equity to get this number. 

As you’re going through your balance sheets, you’ll want to watch out for a few red flags for that signal trouble.

• Your debt-to-equity ratio is more than 100% — You have more debt than you can handle.
• Your liabilities are consistently higher than your assets — You don’t have enough assets to cover your liabilities.
• Your outstanding share count keeps increasing— You’re selling too many shares and weakening the business’ value.

As you analyze your balance sheets, you’ll use your income statements to complement that data and get a better view of your finances and operations.

Reading an income statement 

An income statement tells you how much money you’ve spent and how much you’ve earned over a specific period of time. For example, you can prepare an income statement that shows all your profitability from January to March of your fiscal year.

Components of an income statement

Your income statements take in a lot of factors and categories when spelling out your profits. These can include:

• Revenue — How much money you’ve made
• Expenses — How much money you’ve spent running your business
• Cost of goods sold (COGS) — The total cost of parts to produce what you sell
• Gross profit — Your total revenue after COGS
• Operating income — Your total revenue minus the costs needed to run your business
• Income before taxes — Your earnings before subtracting tax liabilities 
• Net income — Your total revenue minus expenses, taxes, and payroll
• Earnings per share — Your net income divided by your total number of outstanding shares
• Depreciation — The cost of your assets after they lose value over time
• EBITDA —  Your earnings before interest, taxes, depreciation, and amortization

After seeing everything you’ve brought in and spent within your business, you’ll want to know if you’re using your money wisely and actually turning a good enough profit. 

Analyzing income statements

Once you’ve calculated all the various categories within your income statements, there are formulas you can use to determine your overall profitability. 

• Gross profit margin — This type of vertical analysis (only looking down a single column) lets you determine how much you make per dollar spent. To figure out this figure, you’ll subtract your COGS from your sales revenue and divide that number by the original revenue number.
• Operating profit margin — This formula accounts for your overall expenses on top of gross profit. To calculate this number, multiply your EBITDA by your operating income and divide the result by your sales revenue.
• Net profit margin — This shows how much you keep after covering all of your expenses. To get this number, simply divide your net income by your sales revenue.

As you go through your income statements, certain red flags are signs of grey skies.

• Declining gross profit margin — You’re not bringing in enough money to cover or scale operating costs.
• Large “other” expenses — You don’t know exactly what these high-value items are and can’t determine if they’re helping or hurting your business.
• Increasing accounts receivable — Customers are taking too long to pay you, and you’re not receiving timely compensation for delivered services or products.

Reading cash flow statements

Rounding out your main three types of financial statements is the all-important cash flow statement. Cash flow statements show the amount of money (you guessed it) flowing in and out of your business. It shows you and investors where money is coming from, where it’s being spent, and how you’re using that money to run your business’s overall operations. You’ll produce these reports to cover a specific time period.

Components of a cash flow statement

Cash flow statements report the financial activities within three categories across your business. They’re your:

• Operating activities — This is the way you use cash to run the business, as well as where the cash comes from. It can include your cash accounts receivable, accounts payable, inventory, payroll, rent costs, debts, income tax payments, and depreciation.
• Financing activities — This covers cash from investors and banks as well as any cash you pay to shareholders. It can include loans, debt repayment, debt or equity issuance, and paid dividends.
• Investment activities — This is any money you’ve used or have from investments in your business’s future. It can include the sale or purchase of assets, merger or acquisition payments, or vendor or customer loans. 

Since your cash flow is a big indicator of financial stability, you’ll want to look at these numbers carefully to ensure you have a long runway of funds.

Analyzing cash flow statements

When it comes to analyzing your cash flow, there are two common methods you can use. 

• Direct method — This method accounts for relevant cash from your operating activities within the analyzed time period. To determine this number, subtract your operating cash output from your operating cash collections.
• Indirect method —  This method accounts for cash that goes in and out of your business outside of the analyzed time period. To get this figure, you start with the net income number from your income statement and work backward, subtracting non-cash expenses.

In the end, you’ll either end up with a positive or negative cash flow. 

• A positive cash flow means you’re bringing in more money than you put out.
• A negative cash flow means more money leaves your business that comes in.

Just like your other financial statements, don’t miss any important red flags.

• Fluctuating cash flow — You could be mismanaging your accounts receivable or payable or consistently experiencing unexpected expenses.
• Highly used credit lines — You’re really tight on cash and wracking up more credit debt to stay afloat.
• Bloated cash outflows — You’re spending too much to run your business without bringing in enough to balance it out.

These financial statements combine to give you a bird’s-eye view of your financial health so you know exactly how you’re managing your money and if it’s working in favor of your business. 

Reading nonprofit statements

If you’re a nonprofit, you need to know how to read slightly different statements.

Remember: the differences in profit versus nonprofit financial statements are not vast. But those changes matter when it comes to correctly preparing the documents for donors, investors, and government agencies.

As a nonprofit, you’re responsible for delivering and analyzing a:

• Statement of activities — Unlike balance sheets, this document doesn’t include equity positions. Any funds left after liquidating assets and covering liabilities are called “net assets.”
• Statement of financial positions — Instead of the categories on an income statement, this will track your donations, grants, revenue from events, and expenses.
• Statement of cash flow — While still detailing operating, investing, and financial activities, you’ll use this report slightly differently depending on the nature of your nonprofit.
• Statement of functional expenses — This report specifically breaks down administrative, program, or fundraising expenses so the public can see how you’re using your funds to support your mission.

No matter what kind of small business you have, all these financial statements need to be accurate. Only then can you successfully manage your money and grow your business without worrying about how you’ll cover your bills or finding yourself in hot water with the IRS. 

Forget worrying about financial statements

While you can learn to easily read financial statements, making them from scratch can be something else entirely. 

Building balance sheets and inspecting income statements only becomes more complex as your business grows—but you don’t have to go it alone. You can take advantage of outsourced accounting services to get the help you need to effectively report your financial activities.

Hiline partners with you to develop a financial plan tailored to your unique business. From prepping financial statements to providing strategic financial analysis, we’re by your side as you scale your small business.

Discover the Hiline difference today.

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