Financial Statements Guide: How to Prepare Balance Sheet, P&L, and Cash Flow

Preparing financial statements is the process of classifying financial transactions, verifying balances, and preparing reports that show both business performance + financial position.

Are you a business leader who sees financial statements as mere “compliance documents”?

If that’s a YES, be ready for the following surprises: 

• You may see healthy sales figures while cash in the bank keeps tightening. 
• Revenue may rise year after year, yet financial stability quietly erodes. 
• Growth may look strong on paper, but risk builds through debt, delayed collections, or weak cash flow. 

Are these accounting problems? Nope! These are visibility problems. Always remember that financial statements are not reports prepared for auditors alone. They are “management tools” that explain:

• How money is earned
• Where is it locked
• What truly belongs to the business

When read together, they reveal patterns that sales dashboards cannot show! But these benefits can be realized only when you know which financial statements to use + how to prepare them. Read this article to learn how the income statement, balance sheet, and cash flow statement work together, what each one reveals, and how you can prepare them in simple steps.

The 3 Major Financial Statements

Among a wide variety of reports available, most businesses usually prepare these three basic financial statements:

• Income Statement
• Balance Sheet
• Cash Flow Statement

Okay, but what do they show? Together, they explain:

• How the business earns money
• What it owns and owes
• How cash moves in and out

Remember that each statement serves a different purpose, but all three are closely linked and must be read together to understand the true financial position of a business. Now, let’s learn in detail about these financial statements: 

I) Income Statement

An income statement (also called a profit and loss statement) tells you whether your business made money or lost money during a fixed period (usually one financial year). It compares what you earned from sales with what you spent to run the business. Without it, you cannot clearly see if your business activities are profitable. 

It answers one basic question: After all costs, did the business make a profit? And to calculate this profit, the income statement covers the following items:

A) Revenue: Your Total Sales

Revenue is the total value of goods or services you sold during the period. This appears at the top of the statement. If you offered discounts, returns, or price reductions, these are subtracted from total sales. What remains is your actual sales figure!

B) Cost of Goods Sold (COGS): Direct Costs

Cost of goods sold includes costs directly linked to what you sold. They show how much it costs to generate sales. Items bought but not sold remain inventory and are not counted here. 

C) Gross Profit: Profit From Core Activity

Gross profit is calculated by subtracting COGS from revenue. This figure shows how much money remains after covering direct costs. A low gross profit may signal high purchase costs or pricing issues. This number does not include office expenses or loan interest.

D) Operating Expenses: Running the Business

These are costs required to keep the business running but not tied directly to sales. Common examples include:

• Rent
• Salaries
• Utilities
• Insurance
• Marketing
• Travel
• Office supplies

These expenses are grouped as selling, general, and administrative expenses. Tracking them allows you to control overhead and plan budgets.

E) Operating Income: Business Performance

Operating income shows profit after subtracting “operating expenses” from “gross profit”. It reflects the profit generated from day-to-day business activities. This figure allows owners to understand whether the business model itself is sustainable, without considering loans or taxes.

F) Finance Costs: Cost of Borrowing

Finance costs include interest paid on loans or credit used by the business. These costs are shown separately because they relate to funding decisions (not daily operations). Most VPs and directors of D2C companies keep them separate to compare operating performance across periods.

G) Net Income: Final Result

Net income is the final profit or loss after deducting finance costs. This is often called the “bottom line”. It shows how much the business earned during the year. 

• A positive number means “profit.”

and

• A negative number means “loss.”

II) Balance Sheet

A balance sheet shows the financial position of your business on a single date, usually the last day of the financial year. Unlike the income statement, which covers a period, the balance sheet is a snapshot. 

It answers these three core questions: 

• What does the business own?
• What does it owe?
• What is left for the owner? 

An analysis of the balance sheet allows you to assess stability, borrowing capacity, and long-term sustainability.

The Three Parts of a Balance Sheet

Every balance sheet has three sections: assets, liabilities, and owner’s equity. These three parts are connected by a simple idea:

• Assets = Liabilities + Owner’s Equity

This means everything the business owns is funded either by money it owes or money invested by the owner. Now, let’s understand these three parts in detail:

1. Assets: What the Business Owns

Assets are resources owned by the business that have value today or in the future. These items help the business operate and earn income.

Note that:

• Current assets show short-term strength. 

and

• Non-current assets show long-term investment in the business.

2. Liabilities: What the Business Owes

Liabilities are obligations the business must pay to others, such as banks, suppliers, or employees.

Liabilities show how much of the business is funded by borrowed money.

3. Owner’s Equity: What Belongs to You

Owner’s equity is the value left after subtracting liabilities from assets. It represents the owner’s investment plus retained profits. Mathematically, it is represented as follows:

• Owner’s Equity = Assets – Liabilities

A growing equity balance usually indicates a strengthening business.

III) Cash Flow Statement

A cash flow statement tracks how cash moves in and out of your business during a chosen period. This period can be a year, quarter, or month. Unlike other financial reports, this statement focuses only on cash and bank balances. It shows:

• Where did the cash come from (source)?
• How was it used (expenditure)?
• Why did the “closing cash balance” change?

Why Profit Is Not the Same as Cash

Always remember that your income statement records sales and expenses when they are earned or incurred and not when cash is received or paid (as per the rules of the accrual system). Now, this creates a timing gap! But how?

• You may record a sale today, but receive payment weeks later. 
• The same applies to expenses recorded before payment. 

Due to this timing gap, the balance sheet shows how much cash you have on a specific date, but it does not explain how that cash was generated. The cash flow statement fills this gap by explaining the source + use of cash.

The Three Sections of a Cash Flow Statement

To better represent the movement of cash, a cash flow statement is divided into three sections. Each section answers a different question about cash movement. Let’s learn about them:

Prepare Financial Statements in These 5 Easy Steps!

Now that you have understood the three major financial statements, let’s understand how you can prepare them in five simple steps:

Step I: Bring All Your Numbers Into One Place

Firstly, you need all your “financial records” in one place. Generally, this includes:

• Sales invoices
• Purchase bills
• Expense receipts
• Bank statements

These records show how money comes in and goes out. If anything is missing, your final numbers will be wrong. Many senior managers of D2C companies struggle here because data sits in emails, files, and bank apps. 

Okay, any solution? You may start using accounting software, which can pull payments, invoices, and expenses into a single system. Alternatively, you may hire an established accounting outsourcing company, like Atidiv. This reduces manual work and lowers the risk of missed or duplicate entries. 

Step II: Sort Your Data Into Clear Buckets

Once the data is collected, the next step is sorting it into the following clear categories:

• Income shows what you earn. 
• Expenses show what you spend. 
• Assets are what the business owns, such as cash or equipment. 
• Liabilities are what the business owes, such as loans or unpaid bills. 

This step is highly important because preparing financial statements depends on “correct grouping”. If an expense is marked as income, your profit will look higher than reality. When you use accounting software, it usually allows you to assign categories while entering data. This could keep records consistent + easier to review later.

Step III: Create the First Set of Financial Reports

After sorting the data, you prepare the three basic financial statements (as explained above). Remember that these are not final reports, but they give a clear picture of financial health. Most business owners use them to:

• Check profitability
• Control costs
• Plan future spending

The quality of these statements depends fully on how accurate the earlier steps were.

Step IV: Check Every Number Against Real Records

After preparing the financial statements, the next step is to verify them. This means matching the figures in your reports with:

• Bank statements
• Loan statements
• Tax records
• Vendor documents

For example, the cash balance in your books should match your bank balance after adjusting for pending payments. The advantage? This allows you to catch:

• Missing entries
• Duplicate transactions
• Wrong amounts

If calculations were done manually, totals must be rechecked. Tax and loan figures also need confirmation, since errors here can lead to compliance issues.

Need Help? Let Atidiv Prepare Financial Statements of Your Business in 2026!

So now you know about the three financial statements and how to prepare them. Together, the income statement, balance sheet, and cash flow statement give a complete view of business performance + financial position. If we were to recap, the process of preparing financial statements is:

• Collect all financial records from sources
• Classify income, expenses, assets, and liabilities
• Prepare draft financial statements
• Reconcile data with bank and third-party records
• Correct errors and adjust balances
• Finalise statements for the reporting period

Need assistance in preparing or maintaining your books of accounts? Atidiv is a leading US accounting firm with 70+ global clients. With 16+ years of experience, Atidiv offers comprehensive bookkeeping services, financial advisory, finance process optimisation, and more. 

Hire us today and let our team of 390,000+ chartered accountants and CPAs support your business from day one. Book a free call to learn more.

Prepare Financial Statements FAQs

1. Why does my business show profit but still face “cash shortages”?

Profit is recorded when sales are made and not when money is received. If customers pay late or expenses are paid upfront, cash can run short. The cash flow statement shows the real movement of money and explains this gap.

2. How often should I review my balance sheet and cash flow statement?

You should review them at least quarterly. On the other hand, “monthly reviews” are better for growing D2C companies and consumer brands earning $5M+ revenue. Always remember that regular checks allow you to:

• Spot rising debt
• Falling cash
• Weak asset positions

3. What balance sheet items do banks focus on before approving loans?

Most commercial banks mainly review:

• Cash balance
• Outstanding loans
• Total liabilities
• Owners’ equity

They want to see if the business has enough assets to repay debt and whether the owner has invested enough capital.

4. Which cash flow section matters most for business survival?

Cash from operating activities matters most. It shows whether daily business operations generate enough cash to cover expenses. Positive operating cash flow means the business can run without depending heavily on loans or owner funding.