How to Read Your Company's Financial Statements — A Guide for Non-Accountants
The average SIA owner receives a folder of documents from their accountant once a year. Balance sheet, profit and loss statement, notes. The words are familiar, the numbers are in their place, but what do they actually mean? Most owners glance at the bottom line — "profit" — and sign. That's like driving a car while only watching the speedometer and ignoring the fuel gauge, the oil pressure, and the coolant temperature. Sooner or later, the engine stops.
This guide is for anyone who wants to understand their company's financial statements without an accounting degree. We'll explain the three main documents — the balance sheet, the profit and loss statement, and the cash flow statement — in plain language, with real examples.
Key takeaways
The balance sheet is a "snapshot" at a specific date (Assets = Liabilities + Equity), the profit and loss statement is a "movie" over a period, and the cash flow statement shows where the cash actually went
In Latvia, micro and small companies aren't required to prepare a cash flow statement — a balance sheet, profit and loss statement, and notes are enough; medium and large companies are required to prepare it (along with a statement of changes in equity)
Profit and the cash balance in the bank are usually different numbers — the reason lies in receivables, inventory, fixed asset purchases, and loan repayments
Negative equity is a serious warning sign, but it is not automatically legal insolvency — a significant share of Latvian companies have negative equity, and many keep operating normally
Five ratios worth tracking as an owner: the liquidity ratio, the receivables turnover ratio, the gross profit margin, the equity ratio, and EBITDA
The three key financial statements — what each one tells you
A company's financial statements consist of several documents, each offering a different view of the company's position:
The balance sheet — a "snapshot" of the company on a specific date. It shows what the company owns (assets), what it owes (liabilities), and what's left for the owners (equity). The balance sheet answers the question: "What is the company's financial position right now?"
The profit and loss statement (P&L) — the company's "movie" over a period. It shows how much the company earned (revenue) and spent (expenses) over a given period, usually a year. The P&L answers the question: "Is the company profitable?"
The cash flow statement — shows where cash came from and where it went. It's the most useful document for understanding why a profitable company can still run out of cash.
Which companies must prepare what
The Annual Reports and Consolidated Annual Reports Law sets different requirements depending on company size:
Micro and small companies (which includes most Latvian SIAs) only need a financial statement consisting of a balance sheet, a profit and loss statement, and notes. A cash flow statement and a statement of changes in equity aren't mandatory, although many companies prepare them voluntarily because they're useful for management decisions.
Medium and large companies must include a cash flow statement and a statement of changes in equity in addition to the balance sheet, P&L, and notes.
So if you run a small or micro company and your accountant hasn't prepared a cash flow statement, that's not a violation. But as you'll see below, this statement is often more valuable than the profit figure itself, so it's worth requesting even when the law doesn't require it.
The balance sheet: assets, liabilities and equity
The balance sheet rests on one fundamental equation:
Assets = Liabilities + Equity
This equation must always balance — hence the name "balance sheet." Total assets must always equal total liabilities plus equity. If they don't match, there's an error somewhere.
Assets — what the company owns
Assets are everything the company owns that has value. They're split into two groups:
Non-current assets (fixed assets):
Real estate (office, factory, land)
Equipment and machinery
Vehicles
Long-term investments (for example, shares in other companies)
Intangible assets (software, licenses, patents, trademarks)
These assets are used for more than a year, and their value gradually decreases through depreciation.
Current assets (short-term assets):
Cash at the bank and on hand
Receivables — money customers owe for invoices issued but not yet paid
Inventory — raw materials, work in progress, finished goods
Short-term securities and deposits
Current assets are the ones expected to be used or converted into cash within a year.
Liabilities — what the company owes
Liabilities are also split into long-term and short-term:
Long-term liabilities (creditors):
Bank loans with a repayment term longer than a year
Lease liabilities
Debts to related companies (if repayment is due after a year)
Short-term liabilities:
Payables — unpaid supplier invoices
The portion of short-term loans due within a year
Tax liabilities (accrued but not yet paid taxes)
Accrued liabilities (for example, unpaid wages, vacation reserves)
Equity — what's left for the owners
Equity is the difference between assets and liabilities — theoretically, it's the amount that would be left for the owners if all assets were sold and all liabilities paid off. It consists of:
Share capital — the initial contribution stated in the articles of association
Reserves — mandatory and voluntary reserves
Retained earnings — all profit earned to date but not yet distributed
How to read a balance sheet — practical tips
Compare receivables and payables. If receivables (money customers owe you) are significantly higher than payables (money you owe suppliers), that can point to a cash flow gap — you're effectively financing your customers.
Check the equity-to-total-assets ratio. In practice, a common rule of thumb is: if equity is less than 30% of total assets, the company relies heavily on borrowed funds. This 30% threshold isn't set in law — it's a widely used financial analysis guideline, and the acceptable value varies significantly by industry (for example, a lower equity ratio is normal in capital-intensive manufacturing or real estate, while service businesses typically run higher).
Watch the cash balance and the sign of equity. Cash is the first line under current assets — a declining balance over the years can signal cash flow problems even when profit figures look good. If equity turns negative (liabilities exceed assets), that's a serious warning sign — but not automatically legal insolvency. According to publicly available data, roughly a third of Latvian companies operate with negative equity, and many of them continue operating normally for years. Legal insolvency under the Insolvency Law is generally tied to an actual inability to pay debts within a set deadline, not just a balance sheet figure — though a persistently negative equity position usually means it's time to review the business model or consider additional capital.
The profit and loss statement — from revenue to profit
If the balance sheet is a photograph, the P&L is a movie — it shows the company's operating results over a period.
P&L structure
Latvia's Annual Reports Law allows two alternative P&L formats — by nature of expense (materials, labor, depreciation, etc., shown as totals) or by function/cost of sales (the more common and easier-to-follow format for trading and service companies). Below is the second, more common format:
Net turnover — revenue from core operations. This is the first and often the most important line. It shows how much the company sold in goods or services.
Cost of goods sold — costs directly tied to producing the goods or delivering the service: materials, raw materials, direct labor.
Gross profit = Net turnover – Cost of goods sold. This shows how efficient the core operations are before administrative, selling, and financial costs.
Administrative and selling expenses — office rent, accounting, management salaries, marketing, advertising.
Other income and expenses — foreign exchange gains, penalties, gains or losses from selling fixed assets.
Profit before tax — profit before corporate income tax. Under Latvia's corporate tax system, this line is less critical than in classic tax systems, since corporate income tax is calculated on distributed profit rather than accounting profit.
Profit for the reporting year — the final result after all expenses.
Other companies (for example, manufacturers with a complex cost structure) may show the first format instead, where costs aren't split by function but grouped by nature — this doesn't change what the P&L means, only how it's organized.
The most important P&L lines to watch
Gross profit margin. Calculated as: (Gross profit / Net turnover) × 100. For example, if turnover is €100,000 and gross profit is €40,000, the margin is 40%. This shows how much of every euro sold stays with the company after direct costs. A declining margin over the years can point to rising costs or pricing pressure.
Administrative cost ratio. If administrative costs grow faster than turnover, the company is becoming less efficient. In a healthy situation, turnover growth should outpace the growth of administrative costs.
Profit before tax to turnover. This ratio shows overall profitability. 10% is a good figure in most industries, but it depends heavily on the sector. In food retail, 2–3% can be normal; in IT consulting, 20–30% is common.
Why profit and the cash balance are different numbers
This is one of the most confusing aspects of business finance. Your P&L shows a profit of €50,000, but there's only €5,000 in the account. Where did the cash go?
Reasons:
Receivables. You issued invoices that haven't been paid yet. Profit is recognized when the invoice is issued, not when the cash is received.
Inventory. You bought raw materials or goods that haven't been sold yet. The cash is spent, but the cost only shows up in the P&L once the goods are sold.
Fixed asset purchases. If you buy new equipment for €20,000, the cash leaves immediately, but the P&L spreads this cost gradually as depreciation over several years.
Loan repayment. Repaying the principal on a loan reduces your cash balance but isn't a P&L expense — only the interest portion shows up in the P&L.
To understand where the cash went, you need to look at the cash flow statement — even if the law doesn't require your company to prepare one.
The cash flow statement — the company's circulatory system
The cash flow statement splits every cash movement into three categories:
Operating cash flow. Cash coming in from customers, and cash going out to suppliers, employees, and taxes. This is the most important category — if operating cash flow stays negative for a long time, the company can't sustain itself from its own operations.
Investing cash flow. Cash spent on acquiring long-term assets (equipment, property), and cash received from selling them. Negative investing cash flow in a growing company is normal — you're investing in the future.
Financing cash flow. Cash received from loans or investors, and cash paid out for loan repayments, dividends, or share buybacks. Positive financing cash flow means the company is raising external capital.
Key financial ratios every owner should track
Even if you don't understand the entire statement, track these five ratios:
1. Liquidity ratio (current ratio). Current assets / Current liabilities. This should be above 1.0 — ideally 1.2–2.0. Below 1.0, the company may struggle to pay its bills over the coming year.
2. Days sales outstanding (DSO). (Receivables / Net turnover) × 365. Shows the average number of days it takes customers to pay their invoices. For a more precise calculation, it's better to use the average receivables balance (average of the opening and closing balance) rather than just the closing balance — but the simplified formula is fine for everyday tracking. If this number rises, your cash is sitting with customers longer.
3. Gross profit margin. (Gross profit / Turnover) × 100. A 2–3 percentage point drop in margin can wipe out net profit entirely.
4. Equity ratio. (Equity / Total assets) × 100. As a rule of thumb, a ratio below 30% points to a high reliance on borrowed capital — but as noted above, this isn't a statutory threshold, and the acceptable value varies by industry.
5. EBITDA. Profit before interest, corporate income tax, depreciation, and amortization. This ratio approximates the company's ability to generate cash from its core operations. Investors and banks often use it when valuing a company.
Warning signs in your own financial statements
Learn to recognize these red flags:
Rapidly rising receivables without turnover growth. Customers are paying slower and slower, and you're becoming their bank.
Inventory growing faster than turnover. The company is producing or buying more than it can sell. Cash is frozen in the warehouse.
Current liabilities exceeding current assets. The company may struggle to pay its bills in the near term.
Administrative costs growing faster than turnover. The company is becoming less efficient.
Negative operating cash flow for three or more months in a row. A serious warning, even if profit figures look fine.
Persistently declining, negative equity. In a single year, this may not be critical, but if the trend continues over several years, it means the company is eating into its own future.
Reading financial statements isn't hard once you understand the basic principles. It's a skill that directly affects your ability to make the right business decisions — when to invest, when to cut costs, when to ask a client to pay faster. Our team helps business owners not just prepare these statements, but understand them — so you always know what the numbers are telling you about your company. Get in touch, or see our accounting services.
Frequently Asked Questions
Do small companies in Latvia need to prepare a cash flow statement?
No. Micro and small companies (which covers most Latvian SIAs) only need a balance sheet, a profit and loss statement, and notes. A cash flow statement and a statement of changes in equity are mandatory only for medium and large companies, though any company can prepare them voluntarily since they're useful for management decisions.
Why does the balance sheet always have to balance?
Because the balance sheet shows the same value from two sides — what the company uses (assets) and how it's financed (liabilities + equity). If the totals don't match, there's an error in the accounting records that needs to be found and corrected.
What does it mean if a company has negative equity?
It means accumulated losses have exceeded the capital originally invested, and formally, liabilities exceed assets. It's a serious warning sign, but not automatically legal insolvency — a significant share of Latvian companies have negative equity, and many keep operating for years. Still, a persistent negative trend suggests it's time to review the business model or consider additional capital.
Why can profit on the P&L and the cash balance in the bank be completely different numbers?
Because the P&L reflects income and expenses on an accrual basis (when the invoice is issued, not when the cash is received), while the bank account reflects actual cash movement. Receivables, inventory, fixed asset purchases, and loan principal repayments are the typical reasons these numbers differ.
What counts as a good liquidity ratio?
A common guideline is above 1.0, with a comfortable range of 1.2–2.0. Below 1.0 means current assets don't cover current liabilities, which can lead to payment difficulties in the near term.
Is EBITDA the same as profit?
No. EBITDA is profit before interest, corporate income tax, depreciation, and amortization — it shows the core business's ability to generate cash, regardless of how the company is financed or how old its fixed assets are. Investors and banks use it to compare companies, but it isn't "real" profit that can be paid out as dividends.
See also: the SIA annual report and cash flow for a small business.
Sources
Last updated: September 2026. Information based on the Annual Reports and Consolidated Annual Reports Law.
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