Which financial statement best speaks to the financial health of a business?

Ken is absolutely right. While there's no question that the cash flow statement provides all the important metrics regarding cash, it doesn't tell you what else is looming out there. The cash flow statement and income statement are the better measure of performance looking backwards, but the balance sheet is the only one of the three statements that enables you to get a measure of the company's ability to keep on trading into the future.

That said, the question is a little like asking which of the four wheels on your car is the most important. You need them all!

Wow, I would have to disagree with most of the comments so far, which is not normal. There seems to be a lot of focus on all three of the main financial statements, but their is one that is the key to measuring fianncial health - the balance sheet.

The P&L is a tool to measure profitability, but a profitable company can experieince serious declines in overall financial health. In fact, the balance sheet shows current earning and retained earnings, which is usually all you need to know if you are measuring the actual health of the company.

The statement of cash flow is not about health, it is about the inflows and outflows of cash. Again, it can show great cash flow even if a company has terrible financial health. If the question were: "Which of the three statements would I prefer to receive if I could only receive one?", then I would answer the statement of cash flow. But that wasn't the question!

The balance sheet gives you everything you need to know about overall financial health. While it is a snapshot (as mentioned in one of the other comments), I would recommend it never be looked at in isolation. Month-by-month and year-by-year comparisons put it into context and make it easy to determine if financial health is increasing or decreasing. Most of the financial health ratios, like current ratio, debt-to-equity ratio, fixed asset efficiency, days sales outstanding, inventory turnover, days payables outstanding, and more, are either completely solved or partially determined with the data on the balance sheet.

I agree that the balance sheet is possibly the most important, but I did notice that one important aspect of the statement of cash flows seems to have been over looked here. The statement of cash flows does not just tell me about the inflows and outflows. It tells me where they are coming from. If a company has most of it's cash flows coming from "Operating Activities" then to me that is a sign of a much healthier company that one who's cash flows are primarily being derived from Financing Or Investing activities.

Ultimately I agree that all three need to be analyze together in order to get a fair picture of a company's financial health.

Not sure if I am allowed to answer twice, but it is interesting that a set of professionals all have different answers.

Every statement is crucial in a holistic view of a companies financial health. What I see from experience, and also from working with underwriters and studying microeconomics, is this:

The balance sheet is a snapshot on one particular day and because of that it is restricted when looking into the future (a huge component to financial health). While it is an integral part in looking at a companies financial strength and health, it is like having a picture when you need a video. Even comparing year-over-year, which is very important, it is not always indicative of financial health. I have seen many situations where the balance sheet does not look as healthy year-over-year because of business models, like expansion, yet the company is actually operating in a more profitable manner.

The income statement is important, but because of the complex nature of financial reporting it may not reflect a companies true ability to operate effectively based on the business model.

This is essentially why the cash flow statement exists, to unwind adjustments and look at how successful a company is truly operating. It adjusts earnings, revenues, assets and liabilities to create a clear picture of where cash flow is coming from. In most situations cash flow is the best indicator to an investor of financial health. This is pretty widely recognized. I don't think it is very fair or professional to suggest that someone who understands this, doesn't understand how to read financial statements.

One must understand that the companies business model, the stage of growth that the company is in and other variables may actually change which financial statement is most important. For example, a company may prove the statement of cash flows to actually be useless in the early growth stage because of growth in operating expenditures. By the same token, a balance sheet may be useless in this stage showing little Retained Earnings (someone mentioned this as being crucial), little cash and high debt.

Anyone that says the statement of cash flows is not about financial health need only to do a small amount of research and studying to see otherwise. In-fact, in the mid 1980s when the CFS became mandatory, it was to create a more accurate picture of a companies financial health. Since every opinion seems to be different, I suppose this is just my opinion, expanded on my earlier statement. Seems like many will have to agree to disagree on this opinion. My experience ranges far outside the scope of being a CPA on this particular opinion.

I have to go with the Income Statement.

Year over year revenue growth and net income are the two key metrics to me in evaluating a company.

No question about it, the Cash Flow Statement is the key to demonstrating the financial health of a business. A Balance Sheet is a snapshot of a given point in time that can be easily taken at an optimal moment in time, an Income Statement reflects revenue that is recorded (and related expenses) but does not account for revenue that has been recognized for those customers that have been billed for goods and services but those invoices are still not paid. A CEO that I worked with told me how this impacted him (after I started to explain why the Cash Flow Statement is the best tool) in his business. Simply said, "We found it really tough to meet payroll with net profit numbers that appeared on our Income Statement." You need to understand your cash position (and operating profit) to sustain and grow a business.

My answer comes always from a banker's viewpoint since that is the view that I am used to looking at financial statements. The three components of your company's balance sheet (Income Statement, Balance Sheet, and Statement of Cash Flows) are all equally important. When a lender is looking at your business they examine the financial health of your company in four basic categories:

Liquidity which uses calculations from the balance sheet (and the Statement of Cash Flows). Examples include the current and the acid test ratio.

Profitability which uses calculations from the Income Statement and Balance Sheet. Examples include gross profit margin, return on equity, and return on assets.

Leverage ratios which use calculations from the Balance Sheet and Income Statements. Examples of leverage ratios are debt to equity, shareholder's equity ratio, and times interest earned.

Efficiency ratios which measure how operations is managing assets and debt to generate revenues for the company. Examples include days of A/R outstanding, days of cash available and days of A/P outstanding.

These four categories are all measuring different aspects of the financial health of your business and rely on information found on the totality of your financial statements. Bankers are looking for an acceptable balance in all four areas, though your ability to repay a loan as measured by historical free cash flow may be the most important in today's economy.

Whether you are a company owner reviewing internal company data or an external investor/lender, there are three fundamentally important questions to ask:

(1) How is the company making money?
(2) What are the cash inflows/outflows, in regards to type, quantity and timing?
(3) How is the company financed (or leveraged)?

In an effort to answer these questions, you must look at the income statement, cash flow statement, and balance sheet.

If I were forced to choose only one statement to review (hypothetical as this would never be the case) I would choose the balance sheet. The balance sheet keeps a "score card" of all the years the company has been in business.

The balance sheet provides me the following insights:

(1) Under liabilities I can see the amount of debt-both short and long term.
(2) Retained earnings tells me if the company has been profitable
(3) By comparing accounts receivables to accounts payable I can get a sense of the collections and liabilities (time and quantity)
(3) Balance sheet ratios can be used as key indicators such as debt to equity and assets to liabilities.

Financial health is a term used to describe the company's ability to continue in business (on-going concern in accounting language). The incomes statement tells me how good a company is at selling, producing and delivering products, the cash flow tells me how good a company is at controlling in flows and out flows of cash but the balance sheet, with insights into debt and equity, is speaking directly to the financial health of the company.

I would have to agree with Ken and Geoffrey that the Balance Sheet out of all of the statements speaks most to the Financial health of the business. I would also concur that looking at one of the three is definitely not a best practice either.

- Balance Sheet - provides many indicators of financial health and is used in computing key ratios and net worth measurements
- Income Statement - provides a measure of performance and profitability
- Cash Flow - provides detail on the uses of cash for operations and financing

It is often a pitfall of many SMB's that all three statements are emphasized. Too often I see SMB Owners put all of the emphasis on the Income Statement and none on Cash or the Balance Sheet

Do you concur? Concur? Concur with what? With what he just said. Well, the boy fell off his bike…he told us that. Well then I can see you don’t need me here. Good work, men. Damn it, why didn’t I concur?

I concur with Ken Kaufman. The balance sheet, hands down, is the one statement to choose to determine the health of a business. The income statement and statement of cash flows are not even close. Anyone (my apologies to those who did not choose balance sheet) who would not choose the balance sheet does not know how to read financial statements.

The income statement could show a healthy net profit but what if half of the revenue is still in AR, the AP is one third of all expenses, retained earnings are still well into the red, and the business is burdened by huge debt?

The statement of cash flows will show the changes in AR and AP but not their current balances. It will show debt reductions but not the amount still owed in short and long term debt.

I could go on and on. If you know how to read a balance sheet you can evaluate the health of any business - the same in just not true looking at only the income statement or statement of cash flows.

If you don't know where the first paragraph came from go to your Netflix account and put Catch Me If You Can at the top of your queue.

Joseph - Those are all very compelling arguments. As I see it, the income statement provides a very good picture of how the company did over a period of time (the video), but gives little or no measure of how well and how quickly the accrued profits are translating into cash. The cash flow statement provides that last answer very well and also lets the reader know exactly where the cash came from and how much you have on hand. What it doesn't do is fully clue you in on such things as working capital management and outstanding commitments. That's where the balance sheet comes to the fore. I accept that because the balance sheet is a snapshot, it is the easiest of the 3 statements to manipulate. Just slow down your payments to vendors by a week and you can materially impact the balance sheet, but that same manipulation will also flow right into the cash flow statement, so you're no better off by looking at that. My conclusion: there's a reason why all 3 are mandatory and they all need to be looked at. Also make sure that you do some meaningful ratio analysis. If I were forced to look at one statement only, it would be the balance sheet. If it had a prior year comparative, I could get virtually all the information I needed to form a decent opinion on the company's health.

I am agree with joseph the cash flow statement only show the cash flow activities but not the credit activities so the financial position are not properly known . so the balance sheet is the correct statement asper my knowledge.

mohanty

There is a very good reason that financial statements are presented in their respective order: balance sheet, income statement, equity, statement of cash flows, disclosures. You get the big picture with the balance sheet and then each additional layer adds supplementary information, highlighting areas of special importance. Therefore the basis of accounting is the balance sheet. Whether or not that makes it the most important is a matter of opinion but I will add that anyone who understands the balance sheet can extract 90% of the information of the statement of cash flows from it. Also, I have heard of small businesses that just prepare a balance sheet but I have never heard of anyone who only prepares a statement of cash flows.

Perhaps you didn't fully read the question...

"Which financial statement best speaks to the financial health of a business?"

I don't mean to come off abrasive, but these points made don't hold any substance compared to some of the other advocates for the balance sheet.

All accountants understand that the balance sheet is the foundation of a companies financial reporting along with the income statement. It is also understood that the statement of cash flows is mostly derived from the balance sheet.

It is a matter of opinion, but ironic that the statement of cash flows was created and defined to enhance the ability to analyze the financial health of a company. Why? Because the balance sheet and income statement weren't a sufficient analysis for lenders and shareholders.

A case can be made for either one. The question was not "what is the most important financial statement?" Most companies look at financial health as their ability to generate operating cash flows, based on their business model. Obviously there are many balance sheet items, ratios and so-forth that are just as important.

Ask yourself this, can a company be financially healthy if they are unable to generate positive operating cash flows after the R&D / startup period?? For most, thats an easy answer. Can a company be financially healthy if they have high debt ratios, but are operating with high cash inflows and will continue to improve their balance sheet? Absolutely.

I think the answer is being convoluted by a lack of attention to the actual question. All statements are important. That is not the point of the question. Great arguments are made for the balance sheet, and rightfully so.

One more point, the order of the financial statements is not defined by than their "importance"... It has more to do with how they are inter-connected...

The question is not "what is the most important financial statement", it is “Which financial statement best speaks to the financial health of a business?”

If a company has a solid balance sheet but has failed to generate cash flows from operating activities because of their business model, how long do you expect that balance sheet to appear healthy? Again, a balance sheet is a moments snapshot.

If a company has a balance sheet with poor debt ratios, but has started to generate significant operating cash flows from their business model, which will subsequently affect their balance sheet, what does this really mean for the health of a company? A start-up company is a good example of this.

They are both extremely important. One without the other would would not be adequate in todays world of financial reporting and analysis.

Again, it is ironic that the statement of cash flows was created to enhance the ability for shareholders and lenders to understand the financial health of a company. The statement of cash flows is defined as such..

Also. small businesses.. small business lenders continue to be very primitive in their ability to analyze the health of the business compared to sophisticated high-dollar lenders. I would get into more if I had the time. Most of the responses are great, everyone has a different viewpoint.

do not need a statement, just need two numbers and they say everything about the financial health of the business, OpINC and FCF. except in the early stages of a turn around or a startup, then it life, ie: cash and burn.

How a company is perceived in the public markets is best measured by enterprise value, revenue and cash on hand.