Financial statements are a company's annual financial report that reveals the business results and financial position. Although the accountant prepares the financial statements, it is important for business owners to understand what the figures mean. The ability to interpret financial statements helps make better business decisions, negotiate with financiers, and identify financial risks early.
Components of financial statements
Financial statements consist of the income statement, balance sheet, and notes. Larger companies' financial statements also include a cash flow statement and a report of the board of directors. Each component tells a different side of the company's financial situation, and together they provide the full picture.
Main components of financial statements:
- Income statement – shows the result for the financial year, i.e. whether the company has been profitable
- Balance sheet – shows the company's assets and liabilities at the balance sheet date
- Notes – clarify and explain the figures in the income statement and balance sheet
- Cash flow statement – describes the movement of funds (mandatory for larger companies)
- Report of the board of directors – management's description of business development (mandatory for larger companies)
Interpreting the income statement
The income statement shows how much the company has earned and spent during the financial year. It progresses from revenue downwards, deducting various cost categories, until the bottom line shows the result for the year. In Finland, the income statement typically follows a cost-type format.
Key line items in the income statement from top to bottom:
- Revenue – sales income excluding VAT, the core business revenue
- Materials and services – raw materials, subcontracting, and other variable costs
- Gross margin – revenue minus variable costs, indicates the basic profitability of the business
- Personnel costs – wages, social contributions, and pension payments
- EBITDA – result before depreciation, financing costs, and taxes
- Depreciation – the accounting reduction in value of investments
- Operating profit (EBIT) – result before financing costs and taxes
- Net result for the period – the final result after taxes
From a business owner's perspective, the most important income statement figures are gross margin and EBITDA. Gross margin shows how much margin remains on a product or service after variable costs. EBITDA shows how much the core business generates in cash before the wear of investments and financing costs. A positive and growing EBITDA is a healthy sign.
Interpreting the balance sheet
The balance sheet is a snapshot of the company's financial position at a specific moment – the balance sheet date. It is divided into two sides: assets and liabilities (equity and debt). The total on both sides must be equal – hence the name 'balance sheet'.
On the asset side are the company's resources: non-current assets such as machinery and equipment, and current assets such as inventory, trade receivables, and the bank account. On the liabilities side are equity – owner investments and retained earnings – and debt, including loans and trade payables. Business owners should pay particular attention to the level of trade receivables, as they tie up working capital.
The financier's perspective: Banks and financiers examine the equity ratio (equity relative to total capital), the trade receivables turnover, and the structure of debt in the balance sheet. A strong balance sheet significantly improves financing terms.
Key financial ratios
Financial ratios are calculated from the financial statements to summarise the company's financial health into comparable figures. Ratios are divided into three main groups: profitability, solvency, and liquidity.
Profitability ratios:
- EBITDA margin – EBITDA / revenue x 100, target at least 10%
- Operating profit margin – operating profit / revenue x 100, shows business profitability
- Return on invested capital (ROI) – result / invested capital x 100, shows capital productivity
- Return on equity (ROE) – result / equity x 100, the owner's return perspective
Solvency and liquidity ratios:
- Equity ratio – equity / total assets x 100, target above 40%
- Net gearing – interest-bearing debt minus cash / equity
- Current ratio – current assets / current liabilities, target above 1.5
- Quick ratio – financial assets / current liabilities, target above 1.0
- Trade receivables turnover – trade receivables / revenue x 365 days
What do financiers look for in financial statements?
Banks and other financiers systematically analyse financial statements to assess a company's creditworthiness. According to Finnvera, the three most important assessment areas are profitability, solvency, and liquidity. Profitability indicates the ability to generate results, solvency the ability to absorb losses, and liquidity the ability to meet short-term obligations.
Financiers also pay attention to trends: has revenue grown or declined, have ratios improved or deteriorated? A single weak year can be explained, but a declining trend over several years is concerning. Additionally, financiers check for exceptional items in the financial statements that may distort the normal result.
How to improve your financial statement figures
Improving financial statement figures does not mean accounting tricks but genuine business development. Profitability is improved by increasing gross margin and managing fixed costs. Solvency is strengthened by retaining profits in the company or making additional owner investments. Liquidity is improved by speeding up receivables collection, negotiating longer payment terms with suppliers, and leveraging invoice financing.
Invoice financing has a positive impact on financial statements in two ways. It reduces the level of trade receivables on the balance sheet, which improves trade receivables turnover and quick ratio. It also does not add interest-bearing debt to the balance sheet, so the equity ratio and net gearing are not weakened. This makes invoice financing a financier-friendly cash flow tool.
Summary
📌 Summary
Understanding financial statements is a fundamental skill for every business owner. The income statement shows profitability, the balance sheet shows assets and liabilities, and financial ratios summarise the overall picture into comparable figures. Financiers particularly assess profitability, solvency, and liquidity. Invoice financing improves financial statement figures by reducing trade receivables without adding debt.
