Written by Behdad Karimi Dermeni, CPA · Reviewed by Maryam Ajorloo, CPA
What are financial statements? They are the reports that summarize your business's finances. The income statement shows your profit over a period, the balance sheet shows what you own and owe on a single date, and the cash flow statement shows where your cash came from and where it went. Learning how to read financial statements starts with knowing which question each one answers.
"Accounting is the language of business," as Warren Buffett put it, and you need to be about as comfortable with it as with your own native language. For most Canadian business owners, that comfort arrives roughly never, usually around the moment a banker asks for "your financials" and everyone looks at you.
The good news: understanding financial statements is a lot less scary than scrolling through them makes it feel. This guide explains how to read financial statements in plain language: what each one tells you, how the balance sheet and income statement connect, and what the Canada Revenue Agency (CRA) actually does with them.
If you would rather have the statements built for you while you learn to read them, start free for 30 days and connect your bank. The reports fill themselves in from there.
What Are Financial Statements For?
Financial statements are more than paperwork for your yearly tax filing. Read well, they tell you how your business is doing, what resources you have, and where your money should go next.
Here is the rule of thumb that makes every statement easier: each statement answers one question.
Income statement: did we make money this period?
Balance sheet: what do we own and owe right now?
Cash flow statement: where did the cash actually go?
Keeping your statements accurate and up to date helps with short-term decisions (can we afford to hire?) and long-term planning (should we incorporate, borrow, or expand?). This is also why financial statements are useful for startups: they show you the weak spots before an investor or banker does. Accurate statements start with accurate records, which is why it helps to understand bookkeeping vs accounting: bookkeeping captures every transaction, and accounting turns those records into statements like these.
The 4 Types of Financial Statements
Most Canadian small businesses work with three core statements, and incorporated businesses usually add a fourth:
Income statement (also called the profit and loss statement, or P&L): revenue minus expenses over a period, ending in your net income.
Balance sheet: your assets, liabilities, and equity on a specific date, usually your year-end.
Cash flow statement: the actual cash that came in and went out, split into operating, financing, and investing activities.
Statement of retained earnings: how your corporation's accumulated profits changed during the year (opening retained earnings, plus net income, minus dividends paid to shareholders).
Your accountant may also attach notes to the financial statements, which explain how the numbers were prepared. They are short, and worth reading at least once.
What Is an Income Statement?
Also known as the profit and loss (P&L) statement, the income statement is where your business's revenues and expenses are recorded for a period of time, such as a month, a quarter, or your fiscal year.
Here are the common lines you will see on an income statement:
Sales or revenue: what your business earned from selling its goods or services. This is the "top line."
Cost of goods sold (COGS): costs directly tied to delivering what you sell, such as materials or subcontractors. Many service businesses have little or none. Sales minus COGS is your gross profit.
Operating expenses: the ongoing costs of running the business, like rent, software, marketing, insurance, and salaries.
Operating income: profit from your core operations after COGS and operating expenses. It is sometimes called earnings before interest and taxes (EBIT).
Income before taxes: operating income plus or minus anything outside your core operations, like interest earned or paid.
Income tax expense: the income tax your corporation owes on its profit.
Net income: what is left after every expense and tax. This is the famous "bottom line."
The income statement gives you a quick read on performance. Ratios take it further. Gross margin (gross profit divided by revenue) and net margin (net income divided by revenue) tell you how much of every dollar you keep, and the profit margin calculator does that arithmetic for you. For the full set, see our financial ratios cheat sheet.
What Is a Balance Sheet?
The balance sheet is a snapshot of your business on a single date. It has two sides: one lists everything your business owns (assets), and the other lists what it owes (liabilities) plus what belongs to the owners (shareholders' equity).
It is called a balance sheet because the two sides must always be equal: assets = liabilities + shareholders' equity. If they do not balance, something is missing or recorded twice. (Accountants find this deeply satisfying. Everyone else just finds it reassuring.)
Most Canadian small businesses will see:
Current assets: cash, money clients owe you, and anything else you expect to turn into cash within a year.
Long-term assets: equipment, vehicles, computers, and other things you use for years. Their cost is spread over time through depreciation (called capital cost allowance for tax purposes in Canada).
Current liabilities: credit card balances, bills to pay, and sales tax or payroll remittances owing to the government.
Long-term liabilities: loans repayable over more than a year.
Shareholders' equity: mainly the money shareholders put in for their shares, plus retained earnings (past profits kept in the business rather than paid out).
The balance sheet lets you calculate useful ratios like working capital and the current ratio (current assets divided by current liabilities), which lenders look at closely. Grant programs ask for the same statements, and if you are in Ontario, our guide to Ontario small business grants lists which programs are open and what each application needs.
Balance Sheet vs Income Statement: What's the Difference?
The balance sheet vs income statement question comes up constantly, because both are full of the same kinds of numbers. The difference is about time:
Time frame: the income statement covers a period (January 1 to December 31). The balance sheet is a single moment (December 31).
The question it answers: the income statement asks "were we profitable?" The balance sheet asks "how strong is the business right now?"
What it contains: the income statement holds revenue and expenses. The balance sheet holds assets, liabilities, and equity.
What resets: income statement accounts start from zero every year. Balance sheet accounts carry forward.
How they connect: net income from the income statement flows into retained earnings on the balance sheet. Say your corporation starts the year with $40,000 in retained earnings, earns $60,000 of net income, and pays $20,000 in dividends. It ends the year with $80,000 in retained earnings. That is the whole statement of retained earnings, in one sentence.
So the income statement vs balance sheet answer is not "which one matters more." You need both: one tells you how the year went, the other tells you where it left you.
What Is a Cash Flow Statement?
The cash flow statement explains what happened to your cash during a period. It records the cash that actually came in and went out, which makes it easy to see why your bank balance went up or down.
It has three parts: operating, financing, and investing cash flows. Each one tells you how a different kind of activity moved your cash.
Operating Cash Flows
This part shows cash coming in and going out from day-to-day operations: collecting from clients and paying suppliers, rent, and staff.
It may sound like the income statement, but there is a key difference. The income statement records revenue when you earn it and expenses when you incur them. The operating cash flow shows only the cash that actually moved. So it quickly tells an owner or investor whether the business is good at collecting from clients and paying its bills on time.
Financing Cash Flows
Financing cash flows show money from debt and equity: taking out or repaying loans, issuing shares, and paying dividends.
Example: an online IT consulting business had these financing activities during the year:
Took out a bank loan: +$100,000
Paid off previous debt: -$10,000
Issued shares: +$6,000
Paid dividends: -$30,000
Its financing cash flow is +$66,000, the sum of the four. Together, the total and the detail show how the company raised money and what it paid back to lenders and shareholders.
Investing Cash Flows
Investing cash flows cover buying and selling long-term assets, like equipment, vehicles, property, or investments.
Example: the same IT consulting business had these investing activities:
Bought land for a new office: -$100,000
Bought new equipment: -$10,000
Sold old equipment: +$5,000
That leaves an investing cash flow of -$105,000. A negative number like that can look alarming, but this section shows exactly why: most of it is a land purchase, which is a long-term investment rather than a sign of trouble.
Profit vs Positive Cash Flow: Not the Same Thing
Here is the mistake almost everyone new to financial statements makes: assuming that positive cash flow means you are profitable, or that profit means you have cash. Neither is guaranteed.
Cash flow is about the movement of cash. Profit is measured on an accrual basis, which records revenue when it is earned and expenses when they are incurred, whether or not cash has changed hands.
Say your business finishes a large painting contract in December. On the income statement, that revenue belongs to this year, so you look profitable. But if the client does not pay until March, the cash is not in your account. If they pay late, or not at all, you can be profitable on paper and still unable to pay your own bills this month.
That is why owners who read all three statements sleep better than owners who only check the bottom line. A cash flow projection helps you see that kind of gap before it arrives.
How to Read Financial Statements in 5 Steps
When a set of statements lands in your inbox, work through them in this order:
Start with the income statement. Check revenue, then net income. Compare both with the same period last year: is the business growing, and is it keeping more of what it earns?
Check your margins. Divide gross profit and net income by revenue. A falling margin with rising revenue usually means costs are growing faster than sales.
Read the balance sheet. Confirm assets equal liabilities plus equity, then compare current assets with current liabilities to see whether you can cover what is due in the next year.
Follow the cash. On the cash flow statement, look at operating cash flow first. Healthy businesses generate cash from operations, not just from loans or new shares.
Connect the statements. Make sure net income lines up with the change in retained earnings, and note any big swings in debt, equipment, or receivables. Then write down your questions for your accountant.
Financial Statements and Your Taxes in Canada
Your financial statements are not just a management tool. They also feed directly into what you file with the CRA:
Sole proprietors and partners: you report business or professional income and expenses on the CRA's T2125, Statement of Business or Professional Activities, with your personal T1 return. It is effectively your income statement in tax form. If you are not sure which kind of income you have, our guide to business income vs professional income explains the difference.
Corporations: your balance sheet and income statement go to the CRA with your T2 corporate return, coded using the General Index of Financial Information (GIFI). Schedule 100 carries the balance sheet, Schedule 125 the income statement, and Schedule 141 the additional information about how the statements were prepared. Our corporate tax guide covers the rest of the T2.
Lenders, landlords, and grant programs: they will usually ask for your most recent year-end statements, and often for current year-to-date numbers too.
Many small corporations have their accountant prepare compiled financial statements at year-end. The cleaner your monthly books, the faster (and cheaper) that goes.
This is exactly what ReInvestWealth's financial reports are built for: your income statement and balance sheet update as your transactions come in, so you can read them any month, not just at year-end.
Where Accounting Software Fits In
Understanding financial statements matters. Building them by hand from a spreadsheet is optional, and not recommended for anyone who enjoys their weekends.
Accounting software like ReInvestWealth connects to your bank accounts, uses AI to categorize your transactions, and maps each category to the right line of your statements, including the GIFI codes your corporation's T2 uses. Built by CPAs, it gives you an up-to-date income statement and balance sheet whenever you want one, and you can invite your accountant to work from the same books.
Frequently Asked Questions
What are the 3 main financial statements?
The three main financial statements are the income statement, the balance sheet, and the cash flow statement. The income statement shows profit over a period, the balance sheet shows what the business owns and owes on a specific date, and the cash flow statement shows how cash moved in and out.
What is the difference between a balance sheet and an income statement?
An income statement covers a period of time and shows revenue, expenses, and profit. A balance sheet is a snapshot of a single date and shows assets, liabilities, and equity. They connect through retained earnings: net income from the income statement increases retained earnings on the balance sheet.
Do small businesses in Canada have to prepare financial statements?
Corporations report their balance sheet and income statement to the CRA with their T2 return using GIFI codes. Sole proprietors and partners report business income and expenses on the T2125 with their personal return. Lenders and grant programs also commonly ask for financial statements.
Is a profit and loss statement the same as an income statement?
Yes. A profit and loss statement, or P&L, is another name for the income statement. Both show your revenue, your expenses, and the resulting profit or loss for a period such as a month, a quarter, or a fiscal year.
Can a business be profitable and still run out of cash?
Yes. Profit is measured on an accrual basis, so revenue counts when it is earned, even if the client has not paid yet. If customers pay slowly, or the business spends heavily on equipment or loan repayments, it can show a profit and still be short of cash.
The Bottom Line
Financial statements are how your business talks back to you. The income statement tells you whether this period was profitable, the balance sheet tells you where that left you, and the cash flow statement tells you where the money actually went. Read together, they turn "I think we are doing okay" into an actual answer.
Knowledge is power, but only once it is applied. Connect your bank, let the AI keep your books, and have an up-to-date income statement and balance sheet ready whenever you, your banker, or your accountant ask for one. Start free for 30 days.
A note from our CPAs: This guide is educational and covers the general rules for Canadian small business owners. Tax and reporting situations vary, so for advice on your specific circumstances, talk to your accountant. (If they use ReInvestWealth, they will already have clean books to work from.)
Written by Behdad Karimi Dermeni, CPA
Co-founder of ReInvestWealth and a founding community builder at Stripe. Behdad built ReInvestWealth to give smart, busy entrepreneurs CPA-level accounting without the CPA-level price tag. Read more · Connect on LinkedIn
Reviewed by Maryam Ajorloo, CPA
Maryam Ajorloo is the co-founder of ReInvestWealth and a CPA who specializes in small business tax, sales tax, and everyday bookkeeping. She helps entrepreneurs keep clean, audit-ready books and make sense of write-offs, filing deadlines, and the numbers behind their business. Read more · Connect on LinkedIn
