How to Read and Understand Business Financial Statements

Understanding business financial statements is an essential skill for business owners. You do not need to be an accountant to understand the numbers behind your business, but you should know what your key reports are telling you.

Financial statements can show whether your business is profitable, how much it owns and owes, how much cash is available, and where financial performance is changing.

For New Zealand businesses, financial reporting requirements can vary depending on the nature, size and reporting tier of the entity. The New Zealand Accounting Standards Framework uses a multi-sector, multi-tier approach to determine the applicable reporting requirements.

More importantly for day-to-day management, financial statements give business owners information they can use to make better decisions.

What Are Business Financial Statements?

Business financial statements are structured reports that provide information about a business’s financial position, performance and cash flows.

The main reports business owners commonly work with are:

• Profit and loss statement
• Balance sheet
• Cash flow statement

A business may also use budgets, management reports, accounts receivable reports, accounts payable reports and other financial schedules alongside its formal financial statements.

Business.govt.nz identifies the profit and loss statement, balance sheet, cash flow report and budget as key tools for understanding business finances.

Each statement answers a different question.

Profit and loss: Is the business making a profit?

Balance sheet: What does the business own and owe?

Cash flow statement: Where is the cash coming from and where is it going?

Looking at these reports together provides a much clearer picture than relying on one number.

1. How to Read a Profit and Loss Statement

The profit and loss statement, often called a P&L or income statement, shows financial performance over a particular period.

It generally includes revenue, expenses and profit or loss.

The basic calculation is:

Revenue − Expenses = Net Profit

Business.govt.nz explains that a P&L tracks financial performance over a period and can help business owners understand changes in profitability.

Start With Revenue

Revenue represents income generated from selling products or providing services.

When reviewing revenue, do not simply ask whether sales increased. Consider why they increased or decreased.

For example:

• Did the business gain more customers?
• Did existing customers purchase more?
• Were prices increased?
• Was there a seasonal effect?
• Did one large customer account for the change?

Looking at revenue trends over several periods can reveal whether growth is consistent or temporary.

Look at Cost of Sales

For businesses selling products or services, the cost of sales or cost of goods sold shows costs directly associated with producing or delivering what was sold.

Comparing revenue with these costs helps determine gross profit.

Revenue − Cost of Sales = Gross Profit

Gross profit can provide useful insight into pricing and direct costs.

If revenue increases but gross profit does not improve at a similar rate, it may be worth investigating whether supplier costs, production costs, discounts or pricing are affecting margins.

Review Operating Expenses

Operating expenses are the costs involved in running the business.

Depending on the business, these may include:

• Rent
• Wages and salaries
• Marketing
• Insurance
• Software
• Professional fees
• Utilities
• Depreciation
• Other administrative expenses

Do not only look at the total expense figure. Compare individual categories with previous periods.

A sudden increase in one expense may explain why overall profit has fallen even when revenue remains relatively stable.

Check the Bottom Line

The final profit or loss figure shows what remains after the relevant expenses have been accounted for.

A business can have strong revenue and still produce a low profit if its costs are increasing too quickly.

This is why revenue alone is not a sufficient measure of business performance.

2. How to Read a Balance Sheet

A balance sheet shows the financial position of a business at a particular point in time.

It is generally divided into three categories:

Assets = Liabilities + Equity

Business.govt.nz explains that the three main sections of a balance sheet are assets, liabilities and equity.

Assets

Assets are resources controlled or owned by the business that have economic value.

They may include:

• Cash
• Accounts receivable
• Inventory
• Equipment
• Vehicles
• Property
• Other business assets

Assets are often separated into current and non-current assets.

Current assets are generally expected to be converted into cash or used within the short term, while non-current assets are held for longer-term use.

When reading a balance sheet, consider whether the business has sufficient liquid assets to support its short-term commitments.

Liabilities

Liabilities represent amounts the business owes.

These may include:

• Supplier balances
• Loans
• GST or other tax obligations
• Employee-related liabilities
• Other amounts payable

Liabilities can also be classified according to when they are expected to be settled.

A business with significant debt is not automatically financially unhealthy. Borrowing may be used to fund productive assets or expansion.

The important question is whether the business can manage its obligations and whether the borrowing is appropriate for its financial position.

Equity

Equity represents the owner’s interest in the business after liabilities are deducted from assets.

A simplified calculation is:

Assets − Liabilities = Equity

Changes in equity can provide useful information about how the business has been financed and how profits or losses have accumulated over time.

3. How to Read a Cash Flow Statement

A cash flow statement shows how cash moves into and out of the business during a particular period.

This is particularly important because profit does not necessarily mean that the business has the same amount of cash available.

For example, a business may record a sale but not receive payment from the customer immediately.

Business.govt.nz notes that a cash flow statement provides a clearer picture of available cash than an income statement because it does not treat unpaid accounts receivable as cash received.

Cash flow is generally considered across three areas.

Operating Activities

Operating cash flow relates to the business’s normal activities.

It can include cash received from customers and cash paid to suppliers, employees and other operating expenses.

Consistently weak operating cash flow can be a warning sign that the underlying business is not generating enough cash from its normal activities.

Investing Activities

Investing cash flow generally relates to longer-term assets and investments.

For example, purchasing equipment may create a cash outflow, while selling a business asset may generate an inflow.

A negative investing cash flow is not necessarily a problem. A growing business may spend cash on equipment, technology or other assets that support future growth.

Financing Activities

Financing cash flow relates to activities such as borrowing money, repaying loans or making certain distributions to owners.

A business receiving a new loan may have a financing cash inflow, while repaying debt creates an outflow.

The important point is to understand why cash moved rather than judging every inflow or outflow as positive or negative.

Profit Does Not Equal Cash

One of the most important concepts when learning how to read financial statements is understanding the difference between profit and cash.

A business can report a profit while experiencing cash flow pressure.

Suppose a business makes a large number of sales on credit. Those sales can contribute to revenue and profit, but the cash may not have been received yet.

Similarly, purchasing inventory can use cash before the related products are sold.

This is why the P&L, balance sheet and cash flow statement should be reviewed together.

Key Numbers to Look for in Financial Statements

Business owners do not necessarily need to analyse every line individually during every review.

Instead, start with the numbers that have the greatest impact on the business.

Revenue Growth

Compare revenue across different periods.

Look for consistent growth, declines or unusual fluctuations.

Gross Profit Margin

Gross profit margin helps show how much revenue remains after direct costs.

Gross Profit Margin = Gross Profit ÷ Revenue × 100

A declining margin could indicate rising costs, pricing pressure, discounting or changes in the sales mix.

Net Profit Margin

Net profit margin indicates how much profit remains from revenue after expenses.

Net Profit Margin = Net Profit ÷ Revenue × 100

Comparing margins over time can be more informative than looking at the dollar profit alone.

Accounts Receivable

Check how much customers owe and whether outstanding invoices are increasing.

Growing receivables may indicate that sales are increasing, but they can also create cash flow pressure if customers are taking longer to pay.

Accounts Payable

Review what the business owes suppliers and other creditors.

Large increases may indicate that the business is delaying payments or taking on additional obligations.

Cash Position

Look at available cash and how it has changed.

The cash balance should be considered alongside upcoming payments, debt obligations and expected customer receipts.

Debt

Review the amount and type of borrowing and consider whether repayments are manageable.

Debt should be assessed in the context of the business’s profitability, cash flow and future plans.

Compare Financial Statements Over Time

One financial statement on its own provides limited context.

Comparing financial information across months, quarters or years can reveal trends that are otherwise difficult to see.

For example, you might discover that:

• Revenue is increasing but margins are falling.
• Expenses are growing faster than sales.
• Receivables are taking longer to collect.
• Cash is declining despite reported profits.
• Debt has increased significantly.
• Inventory is growing faster than sales.

These trends can provide early warning signs and help management investigate problems before they become more serious.

Business.govt.nz recommends keeping accurate financial records and reviewing financial information regularly to understand how the business is performing.

Compare Actual Results With the Budget

Financial statements become more useful when compared with the business’s budget.

A budget represents what the business expected to earn and spend, while actual financial results show what happened.

Comparing the two can help identify variances.

For example, if marketing expenditure was budgeted at one level but actual spending is substantially higher, management can investigate the reason.

The same applies to revenue.

A revenue shortfall could result from lower customer demand, pricing changes, seasonal factors or other circumstances.

Regular budget reviews can help business owners respond rather than simply recording results after the fact. Business.govt.nz recommends reviewing budgets based on how the business is tracking.

Questions to Ask When Reviewing Financial Statements

Instead of simply asking whether the business made a profit, ask questions such as:

Is revenue growing at a sustainable rate?

Are gross margins improving or declining?

Which expenses have changed significantly?

Is the business generating enough operating cash?

Are customers paying on time?

Is inventory tying up too much cash?

Has debt increased?

Are actual results significantly different from the budget?

What trends need attention before the next reporting period?

These questions turn financial statements from historical records into practical management tools.

Common Mistakes Business Owners Make

Looking Only at Revenue

High sales do not automatically mean a profitable business.

Costs and margins need to be considered alongside revenue.

Looking Only at Profit

Profit does not show the complete cash position of the business.

Cash flow needs to be reviewed separately.

Ignoring the Balance Sheet

Business owners sometimes focus heavily on the P&L while overlooking debt, receivables, inventory and other balance sheet items.

These can have a major impact on financial health.

Reviewing Statements Only Once a Year

Annual accounts are useful, but waiting until year-end to understand financial performance can make it harder to respond quickly to changing circumstances.

Regular management reporting can provide more timely information.

Focusing on Individual Numbers Without Context

A figure is not necessarily good or bad by itself.

A rise in debt, for example, may be reasonable if the business has borrowed to fund productive expansion and can comfortably service the borrowing.

Context matters.

How Often Should Financial Statements Be Reviewed?

The appropriate frequency depends on the size, complexity and circumstances of the business.

Many businesses benefit from monthly financial reporting because it allows management to identify trends and investigate significant changes while there is still time to act.

Businesses experiencing rapid growth, tight cash flow or significant financial changes may need more frequent monitoring.

Monthly reporting can also make it easier to compare actual performance against budgets and forecasts.

Business.govt.nz recommends keeping financial information up to date and using financial statements and cash flow information to support planning.

Understanding Financial Statements in the New Zealand Context

New Zealand businesses may have different financial reporting requirements depending on their structure, size, sector and reporting obligations.

The XRB Accounting Standards Framework establishes the reporting standards and tiers applicable to different entities. Its purpose includes providing useful financial information while balancing the costs and benefits of financial reporting.

This means business owners should not assume that every business prepares financial statements in exactly the same way.

For businesses with specific statutory reporting obligations, applicable accounting standards and reporting requirements should be considered when preparing financial statements.

When Should You Get Professional Help?

You do not need to become an accountant to understand your business finances.

However, professional support can be valuable when financial statements become more complex or when the business is making significant decisions.

An accountant or business advisor may help with:

• Interpreting financial results
• Identifying unusual trends
• Preparing management reports
• Building budgets and forecasts
• Analysing profitability
• Reviewing cash flow
• Assessing business performance
• Planning for growth
• Understanding financial reporting obligations

Business.govt.nz notes that professional financial help can be useful when a business is complex, the owner is too busy or financial matters are difficult to manage independently.

How Aurora Financials Can Help

Aurora Financials helps New Zealand businesses make better use of their financial information through accounting, financial reporting, budgeting, forecasting and business advisory support.

Financial statements should do more than record what happened. When interpreted properly, they can help business owners understand profitability, cash flow, financial risks and opportunities.

Aurora Financials can help turn financial data into practical information that supports better business decisions, whether that involves improving cash flow, managing costs, planning growth or understanding overall financial performance.

Final Thoughts

Learning how to read financial statements gives business owners a better understanding of what is happening behind their revenue and expenses.

The profit and loss statement shows performance over a period. The balance sheet shows the financial position at a particular point in time. The cash flow statement shows how cash has moved through the business.

None of these reports should be viewed in isolation.

By comparing financial statements over time, reviewing budgets against actual results and investigating significant changes, business owners can gain a much clearer understanding of their business.

The goal is not simply to understand accounting terminology. It is to use financial information to make better decisions.

Frequently Asked Questions

1. What are the three main financial statements?

The three commonly used financial statements are the profit and loss statement, balance sheet and cash flow statement. Each provides a different view of the business’s financial performance, position or cash movements.

2. How do I know if my business is profitable?

Start by reviewing the profit and loss statement. Compare revenue with the business’s costs and examine gross profit, operating expenses and net profit. It is also useful to compare results with previous periods and the budget.

3. What is the difference between a balance sheet and a profit and loss statement?

A profit and loss statement shows financial performance over a period, while a balance sheet shows the business’s financial position at a particular point in time.

4. Why can a business make a profit but have no cash?

Profit and cash are measured differently. For example, sales made on credit can contribute to revenue and profit before the customer actually pays. Cash may also be tied up in inventory or used to repay debt.

5. What should I look for on a balance sheet?

Start with cash, accounts receivable, inventory, debt, other liabilities and equity. Then compare these figures with previous periods to identify significant changes.

6. How often should a business review financial statements?

Monthly reviews are often useful for business management because they allow owners to identify changes in performance and cash flow relatively quickly. The appropriate frequency depends on the business’s size, complexity and financial circumstances.

7. Do small businesses need to understand financial statements?

Yes. Business owners do not need advanced accounting knowledge, but understanding basic financial statements can help them monitor profitability, cash flow, debt and overall financial health.