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The three major financial reports explained

Learn the three major financial reports, how the income statement, balance sheet, and cash flow statement are interconnected and used to analyze business performance.

Kellie Parks
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Woman working at a desk in a modern office space, focused on financial documents. She uses a calculator while reviewing charts and graphs on a printed report. A laptop, smartphone, pens, sticky notes, and a coffee cup are also on the desk. Sunlight filters through patterned glass walls in the background.

Financial reports. It’s a term that puts fear in the hearts of many business owners: they’re both vital and daunting to create and comprehend. 

Financial reporting is an essential component of accounting and bookkeeping. There are many types of financial reports, but the good news is that you don’t need an MBA to understand them if you have the right guidance.

In this article, we’ll explore the three most basic and critical financial reports that every business owner should get to know: Profit & Loss, Balance Sheet, and Statement of Cash Flow. These are the three financial statements that every public company issues annually and quarterly, and they’re a good idea to have on hand for private businesses too. Each one has a story to tell about your business and its performance.

Before diving into the three key financial reports, let’s take a step back and consider what is the objective of financial reporting, and why we need financial reports at all.

The importance of financial reports

Financial reports are not just needless paperwork. They play a vital role in organizing and presenting the business’s financial status to key stakeholders, both internal and external.

Here are a few key reasons financial reporting is so important:

  • Financial visibility: Reports reveal the indicators of a business’s health, such as profit versus loss, cash flow, balance sheets, and more. Business owners use the reports to assess profitability, monitor cash flow and track liabilities.
  • Smarter decision-making: Financial reports help business owners make more informed decisions such as how to effectively allocate resources, plan for growth and address issues before they escalate.
  • Attracting investors and securing loans: Financial reports demonstrate a business’s stability and potential, which is essential for working with investors and loan providers. 
  • Taxation and regulatory compliance: Financial reports are a key component in tax preparation. By tracking and recording the business’s activity, reports also help to ensure compliance with legal and financial regulations.

Difference between financial reports and financial statements

The terms “financial reports” and “financial statements” are often used interchangeably. However, there are some significant differences.

Financial statements are standardized documents that provide a formal overview of a business’s financial position. Examples include the balance sheet, income statement, and cash flow statement.

Financial statements typically provide a snapshot of financial health over a specific period. They’re used for compliance, tax preparation, and high-level financial analysis, primarily  by business owners, investors, financial institutions, and regulatory bodies.

On the other hand, financial reports encompass a broader range of documents that can include financial statements, along with additional analyses and data summaries related to financial performance. They provide a more detailed and often customized view of the business’s financial situation. 

Financial reports examples could be monthly management reports, budget analyses, and sales reports. Generally, financial reports are used internally by the business for performance tracking, strategic planning and decision making, and operational management.

Financial reporting is a complex arena, with a wide variety of reports and statements that businesses can use to get clarity on their finances. What are the three financial statements that should not be overlooked according to Melio experts? Read on.

Comparison graphic titled “Financial Statements vs. Financial Reports – Key differences.” On the left, Financial Statements are described as having a standard format, used for taxes and investors, with examples including Profit & Loss, Balance Sheet, and Cash Flow statements, and are prepared yearly or quarterly. On the right, Financial Reports are described as having a flexible format, used for internal purposes, with examples such as Budgets, Sales, and Management reports, and are produced monthly or as needed. An illustrated character is shown reviewing documents at the bottom center.

1. Profit and Loss (P&L)

The first financial report example is Profit & Loss, which shows the business’s financial performance by comparing incoming and outgoing money over a given time period. The report covers revenue, expenses, and net income.

P&L Accounts

Here are the key items in a Profit & Loss report:

  • Income – revenue from sales and earnings
  • Cost of Goods (or Services) Sold (COGS/COSS) – the cost of products and services needed to directly generate sales
  • Gross profit – income minus COGS/COSS
  • Expenses – the cost of items and services that keep the business operational
  • Other income and expenses – income and expenses that are not a core part of the business’s operations

“Income” refers to revenues generated from sales. It is also important to track the different types of sales, so you may want to include sub-accounts under the “Income” header of your P&L report to paint a more thorough picture.

COGS/COSS, or “Cost of Goods (or Services) Sold”, are the costs directly related to sales. They could be merchant fees, widgets purchased to manufacture products or e-commerce platform fees – any product or service tied directly to a sale. 

For example, let’s say you’re an online retailer or service provider that is paid at the point of sale. Maybe your payment processor takes a percentage, or your sales platform charges a fee, and so your COGS/COSS is high. You don’t have a slow payment problem and you’re not “financing” your customers, but you still have high fees associated with your sales. 

COGS/COSS explains how your sales are great, but the gross revenue is not. Understanding the costs associated directly with sales will help you plan ways to reduce those expenses, perhaps by finding a different sales platform or a new payment processor with better rates.

Moreover, expenses such as rent, payroll , software, and travel must be paid even if you don’t make a single sale.

Controlling your spending is important, but you can only make strategic decisions if you know how much money is coming in, how much you are spending, and where you are spending it to support marketing and sales or to keep business operations running smoothly.

Your P&L report may indicate that you have lots of revenue. But if your customers are slow to pay, the Accounts Receivable (AR) on your Balance Sheet (BS) will be high. The BS AR account tells you how much you are owed. The open, slow-paying, or overdue client invoice data that sits on your BS then tracks to the Statement of Cash Flows (SCF) – more on that later. SCF reports explain why you have good sales but not enough available cash.

2. Balance Sheet (BS)

The Balance Sheet (BS) is a snapshot of a business’s financial position at a given point in time: how much you own and how much you owe. The BS includes all the business’s assets, liabilities and shareholder equity, providing insight into a company’s liquidity, solvency, and financial stability at a specific moment.

BS Accounts

Here are the key items in a Balance Sheet statement:

  • Bank accounts and actual cash – the money that the business has
  • Current assets – assets currently owned or likely to be realized within 12 months
    • Inventory
    • Accounts Receivable – how much the business is owed from customers
  • Long-term assets – assets owned and/or assets that have long-term value
    • Property, plant, & equipment
    • Money owed that is not sales-related
    • Equity – owner investment, preferred shares
  • Short-term liabilities – what the business owes:
  • Long-term liabilities – what the business owes over a longer time period (over 12 months)
  • Retained earnings – money left over after paying all obligations and after paying out dividends
  • Profit/loss – sales minus expenses over a period of time

Retained earnings is a key figure that paints a picture of carry-forward income/loss and signals whether you can take funds out of your business as more dividends, R&D, or new equipment.

AP and AR flow from the P&L (invoices and bills) is key to determining whether you have overdue balances. It may tell you that you need to tighten up payment terms for customers and perhaps get better terms from vendors as well. This situation would be reflected on the Statement of Cash Flow (SCF): your cash is being paid out to vendors while you are holding customers’ balances.

The Equity and Current Assets numbers on the Balance Sheet will tell you if you and any other shareholders have put in or taken out too much money (personally or as partners), which can tie to the SCF.

As its name indicates, the Balance Sheet should always balance out: your assets should equal your liabilities and shareholder equity. If it doesn’t balance out, then there’s an error or miscalculation somewhere in your data, your inventory or your calculations.

3. Statement of Cash Flow (SCF)

Statement of Cash Flow (SCF) shows how much money moves in and out of the business during a given period. It details the cash generated and used in the business’s operating, investing and financing activities. Your SCF is important to increase your cash flow knowledge,  understand your business’s operational efficiency and ability to meet its financial obligations or fund growth.

SCF Accounts

Here are the key items in a Statement of Cash Flow:

  • Operating cash flow – cash flow from core business operations
    • Additions to cash: revenue  
    • Subtractions from cash: expenses  
  • Investing cash flow – activities from purchasing or selling assets 
  • Financing cash flow – activities from debt or equity financing

How are the Three Financial Statements Linked?

Profit & Loss (P&L), Balance Sheet (BS), and Statement of Cash Flows (SCF) are separate financial reports that offer insights into different aspects of a business’s financial health. However, they are also interconnected and affect one another.

For example, the P&L shows net income (or loss) over a period, which flows into the Balance Sheet as retained earnings under “owner’s equity”. Revenue and expenses recorded in the P&L affect the assets and liabilities on the Balance Sheet by either increasing assets or creating liabilities.

The Cash Flow Statement reflects changes in the Balance Sheet accounts, showing where cash inflows and outflows come from by tracking changes in assets, liabilities, and equity. An increase in accounts receivable on the Balance Sheet, for example, reduces cash in the operating section, while an increase in loans payable adds to cash in the financing section.

Together, these three financial statements can provide a more comprehensive view of profitability, liquidity and financial stability, enabling businesses to better understand and manage financial status.

Quick tips for financial reporting

Here are some recommendations for how to set up your P&L, BS and SCF statements more effectively:

  • Number your chart of accounts (or have your accounting professional number it for you). Your accounts will be sorted into a more meaningful order.
  • Use sub-accounts to break down your accounts into smaller accounts to track expenses with more detail. You will have the option of granularity, or you can collapse your reports for easy-to-view financials.
  • Use comparative reports for the P&L and the BS and review them at least once per quarter. It is not enough to know where you stand this month or YTD. You must compare it to previous periods so you can track whether you are growing or shrinking your profits and your cash flow over time.

Key takeaways for how these three financial statements flow together

  1. The Profit & Loss statement monitors how much money is coming into and going out of your business  over a period of time. Key elements of the P&L track to the BS, such as unpaid invoices and bills.
  2. The Balance Sheet gives you a picture of the value of your business at a snapshot in time. A combination of activities is tracked from the P&L and the BS to the SCF.
  3. The Statement of Cash Flow tells you how much cash you have to grow your business or if you’re falling short. And one last reminder: Profit DOES NOT equal cash flow. Even if your business is profitable, you still need to focus on strategically managing your cash flow.

Looking for a payments tool that integrates with your accounting software so you can generate more effective financial reports for your business? Sign up for Melio.

*The purpose of this page is solely to provide information and should not be considered as financial advice
**Melio does not provide legal, tax or accounting advice; you should consult a professional advisor before making any financial decisions.

Kellie Parks is the founder of Calmwaters Cloud Accounting Resources. She crafts processes and automation for future-thinking accounting professionals and business owners who believe in the mightiness of online technology. Certified, partnered, or affiliated with over a dozen cloud applications, she’s also a proud member of the Intuit International Trainer Writer Network and the FreshBooks Partner Council.

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