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A company's financial statements are like a report card—it tells us how well a business is doing. These documents are super important because they help us understand if a company is making money, how much it owns, and how much it owes.

Now, there are three big papers that give us all this info: Income statement, Cash flow statement and Balance sheet. Each one looks at different parts of a company's money stuff. These papers are like a financial roadmap for everyone involved in the company, helping them make smart decisions.

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Income statement

In short: An income statement, also known as a profit and loss (P&L) statement, offers a summary of a company's revenues, costs, and profits over a specific period.

Imagine you are running a bakery. The income statement is like a recipe for understanding how your bakery runs. It reveals what goes in (revenues) and what comes out (expenses), ultimately showing whether you're earning profits or burning through dough. So let’s try to visualize the recipe: 

• Revenue:

Revenue is the total amount of money a business gets from selling its goods or services. 

Let's say, you have a bakery, and you're selling cupcakes. You sell each cupcake for $2. If you sell 5 cupcakes a day, you earn $10. That is your revenue - the total amount you got from selling your cupcakes.

Revenue doesn't take into account how much you've spent on the ingredients like flour, sugar, eggs, or on the electricity to bake the cupcakes, or rent for the bakery shop. It is just the total amount you received from selling cupcakes.

• Cost:

Cost is the amount of money a business needs to spend to make something or provide a service.

The cost of making cupcakes may include the money you spend on ingredients and utilities you need, flour, eggs, sugar, butter, electricity, rent, as well as money you give to the store from where you are running your bakery. They all take a bite out of your profit. Let’s say the total cost is 6$.

• Profit:

Profit is the money a business has left after subtracting all costs from revenue.

Here you get Profit (4$) = Revenue (10$)  – Cost (6$). 4$ is the sweet reward for a well-run bakery. It's positive, so you're baking profit! In another case when it's negative, it's time to adjust your recipe (reduce cost or increase sales or both).

Profit vs cash?

It is often thought that profit is the same as cash that can be used immediately. But that isn't the case. Simply speaking, if you sell a cupcake to your friend and he owes that amount to pay next month, then profit is recorded for this month, but cash will come next month.

An income statement, where you see the profit calculated, is the same. It is a record of transactions at the moment of its agreement, meanwhile cash flow statement is a record of actual, usable cash flowing in and out.

Cash flow statement

In short: A cash flow statement tracks the inflow and outflow of cash within a business over a specific period.

Inflow is ALL the money that your bakery GETS. Just like getting some money from selling your cupcakes which you then put in your piggy bank, that's an inflow.

Outflow, on the other hand, is ALL the money you SPEND. So, you take the money out of your piggy bank to pay for the stuff (ingredients, electricity, rent, etc.) to make your cupcakes. That's an outflow.

Inflow vs revenue? 

'Revenue' is the money you get when you sell your cupcakes at your bakery only.

'Inflow' is all the money that comes into your bakery. For example, beside selling your cupcakes (revenue), your grandma gives you $15,000 to help with the bakery. That revenue from sales and $15,000 are all inflows. 

Outflow vs cost? 

'Cost' is the value of resources consumed. Expenses incurred, both cash and non-cash, related to using resources in the bakery. You have to buy flour, sugar, eggs, and maybe fix the mixer. That's your cost.

'Outflow' is the movement of cash out. All money leaving your bakery, regardless of purpose. So it can be the money to open a new branch of your bakery, or distributing a portion of profits to shareholders.

In other words, inflow and outflow include more than just the cost and revenue from cupcakes. It includes everything else you spent money on or made money from during a specific period of time!

Operating, investing and financing are three activities recorded in cash flow statement:

• Operating activities: 

Operating activities are the core activities related directly to a company's main business operations, like selling goods or providing services.

To run your bakery, operating activities are the everyday things you do to keep your bakery running. This could be compared to doing your regular chores, like cleaning your room. They're routine tasks that need to be done all the time to keep the bakery, or your room, in good shape.

• Investing activities:

Investing activities involve the buying and selling of assets like property, vehicles, or equipment that a company expects will help them earn money in the future.

Did you buy a new mixer? Open a new stall at the market? Or imagine you decide to buy a new, bigger oven so you can bake more cupcakes at once, that's investing.  These are cash outflows for long-term growth.

• Financing activities:

Financing activities involve raising money to run and grow the business. It could be taking a loan from a bank or taking in more money from the owners or shareholders of the company.

Sometimes, your bakery might need a cash boost, right? This is where the financing flow comes in. For example, if your bakery needed more money to buy that big oven, you might borrow some money from a bank, or your parents might put in some of their own money.

Be noted that when we talk about cash flow, we're talking about the actual money that's moving in and out of a business. This money can definitely be used in a business for things like paying employees, buying new equipment, paying rent, or investing in new products. Balance sheet

In short: A balance sheet serves as a financial snapshot of a business at a specific point in time. It includes three components: assets, liabilities and equity.

• Assets are what a company owns. It’s basically everything that can generate money for the company in the future.

• Liabilities are what a company owes to other parties that are not their owner/shareholders. It could be money borrowed from a bank, or money it owes to suppliers for things it bought but hasn't paid for yet. This is utilized as assets to fund business activities and business will have to pay it back later.

• Equity is the portion of the company owned by shareholders or investors. It represents the value of investment from shareholders in the company and is also used as a funding for operating.

The reason it's called a balance sheet is because these three things must ALWAYS BE BALANCED. That means three components are adhered to the equation: Assets = Liabilities + Equity.

The idea behind it is that every asset the company has is derived from some sources: an owner, like a stockholder, or a third party, like a loan. Each dollar possessed by a company is ascribed to either an owner or a non-owner.

This implies that any item possessed by a company is categorized as both an asset and a liability or an asset and an equity:

• Example of an item being categorized as both an asset and a liability:

If you borrowed $10 from your friend to start the bakery, that $10 is an asset (because you now have $10), but it's also a liability (because you owe that $10 to your friend).

• Example of an item being categorized as both an asset and an equity:

If you put $20 of your own money into the bakery to buy more supplies. That $20 is an asset because it's what you used to buy supplies, but it's also equity because it's your personal money that you've invested into the business.