A Practical Guide to Reading the Numbers

Financial statements are a structured way of telling a business’s financial story. They help you understand what the business owns and owes, how it performed over a period of time, whether it generated cash, and what important assumptions sit behind the totals. The goal isn’t to memorize every line item, it’s to read the statements together and notice what’s changing, what’s driving results, and what needs a follow-up question.

The Purpose of Financial Statements

Regardless of how they are presented, financial statements are effectively a scorecard. Their purpose, according to the CPA Canada Handbook Section 1000.15, is to provide information to investors, creditors, and others about:

• the entity’s resources (assets), obligations (liabilities), and equity/net assets;
• any changes to the resources, obligations, and net assets; and,
• the economic performance of the entity.

Depending on the legal question at issue, you may need to refer to different components of the financial statements, as set out below.

Components in financial statements

The financial statements for a profit-oriented company will typically include the five following components:

1. The Income Statement;
2. The Balance Sheet;
3. Statement of Retained Earnings (or Accumulated Deficit);
4. Cash Flow Statement; and,
5. Notes to the Financial Statements.

You may encounter documents that have different names from the five listed above but which convey the same information. For example, a balance sheet may be called a “statement of financial position” and an income statement may be called a “statement of operations” or “profit and loss” (P&L) statement, but these are fundamentally the same.

This introductory article focuses on for-profit corporations. Each of the financial statements is inter-connected  –  together they tell the story of the corporation’s financial condition at a point in time, its profitability or operating performance, and its sources and uses of funds.

1. The Income Statement (The Statement of Profit and Loss)

The income statement explains how the business performed over a period (month, quarter, year). It answers: Did the business make money, and what drove that result?

What you’ll usually see

Revenue (sales) appears at the top. Then the statement subtracts direct costs (often called cost of goods sold or direct labor/materials) to arrive at gross profit. After that come operating expenses such as wages, rent, marketing, and admin costs, which lead to operating income. Finally, interest, taxes, and one-off items are included to arrive at net income (profit).

What to pay attention to

Profit can look strong while the business is actually under stress. That’s because income statements are often prepared using accrual accounting, meaning revenue can be recorded before cash is collected and expenses can be recorded before cash is paid. So the income statement is excellent for measuring performance, but it doesn’t prove the business has cash.

Trends matter more than a single period. A one-time spike in profit might come from a non-recurring gain (like selling an asset), while a slow decline in margins may signal rising costs, weaker pricing power, or inefficiencies.

Important questions worth asking

• If revenue is growing, are receivables growing faster (customers paying slower)? 
• If expenses are unusually low, is something being deferred or reclassified? 
• If there’s a big “other income/expense” line, what is it and will it repeat?

2. The Balance Sheet (The Statement of Financial Position)

The balance sheet is a snapshot on a specific date. It answers: What does the business own and owe right now, and how is it financed?

Assets = Liabilities + Equity

Assets are resources the business uses (cash, receivables, inventory, equipment). Liabilities are obligations (payables, loans, taxes payable). Equity represents the owners’ claim (capital invested plus retained earnings).

Balance sheets are often grouped into current (due/usable within about a year) and non-current items.

• Current assets: cash, accounts receivable, inventory, prepaid expenses
• Non-current assets: equipment, vehicles, property, long-term investments, intangibles
• Current liabilities: accounts payable, credit lines, current portion of loans, taxes payable
• Non-current liabilities: long-term debt, lease obligations, other long-term liabilities
• Equity: share capital/owner contributions, retained earnings

What to pay attention to

The balance sheet is where you judge stability and risk. A business can be profitable but still fragile if it’s highly leveraged or short on liquidity.

Watch for signs like rising receivables, swelling inventory, or a growing pile of short-term debt. These can be totally normal during growth, but they can also hint at cash pressure, slow customers, or stock that isn’t moving.

Important questions worth asking

• Can current assets realistically cover current liabilities? 
• Are there debt repayments coming soon? 
• Are receivables collectible, or are they getting older? 
• Is inventory turning over, or sitting?

3. The Statement of Cash Flows

The cash flow statement tracks actual cash movement over the period. It answers: Did the business generate cash  –  and where did it go?

This is the statement that often explains the classic puzzle: “How can we show profit but still be short on cash?”

The three sections

1. Operating activities: cash generated from day-to-day operations (collecting from customers, paying suppliers and staff).
2. Investing activities: buying or selling long-term assets (equipment, property, acquisitions).
3. Financing activities: borrowing/repaying debt, issuing shares, paying dividends/withdrawals.

What to pay attention to

Over time, healthy businesses tend to produce positive operating cash flow. If operating cash flow is consistently weak while profit looks strong, the gap is usually explained by working capital changes  –  especially receivables and inventory.

Big investing outflows aren’t automatically bad. They can mean the company is upgrading equipment or expanding. The question is whether operations can support that investment or whether the company is relying heavily on new debt.

Important questions worth asking

• Is operating cash flow generally in line with profit over the long run? 
• Are receivables or inventory consuming cash? 
• Is the business funding growth through operations, borrowing, or owner injections?

4. The Statement of Retained Earnings (The Accumulated Deficit)

This statement shows how profits (or losses) have accumulated in the business over time. It answers: How much of the company’s earnings have been kept in the business versus paid out or drawn out?

Retained earnings represent the running total of profits that were not distributed to owners. If the company has more losses than profits over its life, you’ll see an accumulated deficit instead (essentially “negative retained earnings”).

What you’ll usually see

Most versions are short and look like a simple reconciliation:

• Opening retained earnings (or accumulated deficit)
• Plus: net income (or minus: net loss) for the period
• Minus: dividends (corporations) or owner withdrawals/drawings (some presentations)
• Plus/minus: prior period adjustments (if any)
• Equals: closing retained earnings (or accumulated deficit)

Even if the statement isn’t shown separately, the same movement is often reflected within equity on the balance sheet or in a broader “statement of changes in equity.”

Why this statement matters

Retained earnings are one of the clearest indicators of whether a business has been building financial strength over time. A company that consistently earns profits and retains them generally has more flexibility to reinvest, handle downturns, and borrow on better terms.

An accumulated deficit isn’t automatically a deal-breaker. Early-stage companies often run losses while they build. But a long-term deficit can signal a business that relies on external financing, owner support, or debt to keep operating.

Important questions worth asking

• Are retained earnings growing because of real profitability, or are they being offset by large dividends/withdrawals? 
• If the business has an accumulated deficit, what’s the plan to return to sustained profitability? 
• Are there unusual “prior period adjustments” that change past results?

5. Notes to The Financial Statements

Notes are the detail behind the totals. They explain how the numbers were prepared, what judgments were made, and what important details don’t fit neatly on the face of the statements.

You may also see a “Notice to Reader” or compilation notice (common in smaller businesses). This generally signals the statements were prepared from information provided by management, and may not have been audited or reviewed. That doesn’t mean they’re “wrong,” but it does mean you should read them with extra curiosity and ask for support where it matters.

You’ll often find:

• Accounting policies: how revenue is recognized, how inventory is valued, depreciation methods
• Breakdowns of key lines: what’s included in “other,” details of property/equipment, etc.
• Debt details: interest rates, repayment schedules, security, covenants
• Commitments/contingencies: obligations that could become real costs
• Related-party transactions: dealings with owners or connected entities

Why they matter

If something looks unusual in the statements, the explanation is often in the notes. The notes tell you whether a number is the result of a one-time event, a change in policy, a major estimate, or a unique contract.

6. How the Statements Connect

A simple way to connect the package is to follow this logic:

• Profit (income statement) should, over time, help grow equity (balance sheet) and turn into operating cash (cash flow statement). If those links break, ask why.
• For example, if profit is up but cash is down, you often find the reason on the balance sheet: customers owe more (receivables up), inventory is higher, or payables went down because the company paid old bills. 
• None of those are automatically bad  –  but each one changes the story.

Tips on Reading the Financial Statements

Start with the income statement to understand performance and trends. Move to the balance sheet to assess liquidity and debt risk. Then use the cash flow statement to confirm whether profits are showing up as cash. Finally, read the notes to understand policies, debt terms, and anything “non-obvious” behind the totals.

Why Choose Valua Partners? 

Our team combines more than 40 years of specialized experience in financial modelling. We’ve helped business owners across industries make informed decisions with financial models that are accurate, defensible, and respected by lenders, advisors, and regulators. Our team members hold some of the highest designations in the field, including:

• Chartered Business Valuators (CBV) Institute 
• American Institute of Certified Public Accountants – Accredited in Business Valuations (ABV)
• Chartered Financial Analyst Institute (CFA)
• Chartered Accountants of Ontario (CA)
• Chartered Professional Accountants of Ontario (CPA)

How does Valua Partners stand out? 

Valua Partners builds CFO-grade models designed for real stakeholders: management teams, boards, lenders, and investors. We start with the decision you’re trying to make, build a driver-based model with transparent assumptions, and deliver a structure your team can update on a predictable cadence, along with scenarios, sensitivities, and a dashboard that makes the outputs easy to use.

We even provide model audits: we review an existing model for structural risks, broken logic, hardcodes, and missing cash mechanics, and turn it into a version you can trust.

If you’re preparing for a capital raise, acquisition, expansion, or board planning cycle, request a Financial Modelling consultation at Valua Partners. 

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