The average SIA owner receives a folder of documents from their accountant once a year. A balance sheet, a profit and loss statement, and notes. The words are familiar, the numbers are in place, but what do they actually mean? Most owners look at the bottom line — "profit" — and sign. That's like driving a car while only looking at the speedometer, ignoring the fuel gauge, oil pressure, and coolant temperature. Sooner or later, the engine stops.
This guide is for those who want to understand their company's financial reports without an accounting degree. We'll explain the three key documents — the balance sheet, the profit and loss statement, and the cash flow statement — in plain language with real examples.
The Three Key Financial Statements — What Each One Tells You
A company's financial report consists of three core documents, each offering a different perspective on the business:
Balance Sheet — a "snapshot" of the company at a specific date. It shows what the company owns (assets), what it owes (liabilities), and what remains for the owners (equity). The balance sheet answers the question: "What is the company's financial position right now?"
Profit and Loss Statement (Income Statement) — a "movie" of the company over a period. It shows how much the company earned (revenue) and how much it spent (expenses) over a defined period, usually a year. The P&L answers the question: "Is the company making a profit?"
Cash Flow Statement — shows where cash came from and where it went. For micro and small companies in Latvia, it is not mandatory, but it is often the most useful document for understanding why a profitable company can still run out of money. The cash flow statement answers the question: "Where did the money go?"
The Balance Sheet: Assets, Liabilities, and Equity
The balance sheet rests on a single fundamental equation:
Assets = Liabilities + Equity
This equation must always balance — hence the name "balance sheet". The total value of assets must always equal the sum of liabilities and equity. If it doesn't, there's an error somewhere.
Assets — What the Company Owns
Assets are everything the company owns that has value. They are divided into two groups:
Non-current assets (fixed assets):
Real estate (office, factory, land)
Machinery and equipment
Vehicles
Long-term investments (e.g. shares in other companies)
Intangible assets (software, licences, patents, trademarks)
These assets are used for longer than one year, and their value gradually decreases through depreciation.
Current assets:
Cash in bank accounts and on hand
Accounts receivable — amounts clients owe for issued but unpaid invoices
Inventory — raw materials, work-in-progress, finished goods
Short-term securities and deposits
Current assets are those expected to be used or converted into cash within one year.
Liabilities — What the Company Owes
Liabilities are also divided into non-current and current:
Non-current liabilities:
Bank loans with a repayment term longer than one year
Lease obligations
Amounts owed to related companies (if repayable after one year)
Current liabilities:
Accounts payable — invoices from suppliers not yet paid
The portion of long-term loans due for repayment within one year
Tax liabilities (assessed but not yet paid taxes)
Accrued liabilities (e.g. unpaid wages, vacation reserves)
Equity — What Remains for the Owners
Equity is the difference between assets and liabilities — in theory, it's the amount that would be left for owners if all assets were sold and all liabilities settled. It consists of:
Share capital — the initial investment stated in the articles of association
Reserves — statutory and voluntary reserves
Retained earnings — all profits earned to date but not yet distributed
How to Read a Balance Sheet — Practical Tips
Compare receivables to payables. If accounts receivable (what customers owe you) are significantly larger than accounts payable (what you owe suppliers), this may point to a cash flow gap — you are effectively financing your customers.
Check the equity-to-total-assets ratio. If equity accounts for less than 30% of total assets, the business is heavily reliant on borrowed funds. If equity is negative (liabilities exceed assets), the company is technically insolvent.
Track the cash balance. Cash is the first line in current assets — a decline year-on-year can indicate cash flow issues, even if profit figures look healthy.
The Profit and Loss Statement — From Revenue to Profit
If the balance sheet is a photograph, the P&L is a film — it shows the company's performance over a period.
P&L Structure
Net turnover — revenue from the core business. This is the first and often the most important line. It shows how much the company has sold in goods or services.
Cost of goods sold (COGS) — costs directly related to producing the product or delivering the service: materials, raw materials, direct labour.
Gross profit = Net turnover – COGS. This figure shows the efficiency of the core business before administrative, selling, and financial costs.
Administrative and selling expenses — office rent, accounting, management salaries, marketing, advertising.
Other income and expenses — gains and losses from foreign exchange movements, penalties, gains or losses on the sale of fixed assets.
Profit before tax — profit before CIT is calculated. In Latvia's CIT system, this figure is less critical than under a classical tax system because CIT is calculated on distributed profit, not on accounting profit.
Net profit for the year — the final result after all expenses.
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 ratio shows how much of each euro sold stays in the business after direct costs. A declining margin year-on-year can indicate rising costs or price pressure.
Administrative expense ratio. If administrative expenses are growing faster than turnover, the company is becoming less efficient. In a healthy situation, turnover growth should outpace administrative expense growth.
Profit before tax vs turnover. This ratio shows overall profitability. 10% is a solid figure in most sectors, but it is highly dependent on the industry. In food retail, 2–3% may be normal; in IT consulting, 20–30% is common.
Why Profit and Cash in the Bank Are Often Different Numbers
This is one of the most confusing aspects of business finances. Your P&L shows a profit of €50,000, but there is only €5,000 in the bank. Where has the money gone?
Reasons:
Accounts receivable. You have issued invoices that have not yet been paid. Profit is recognised when the invoice is issued, not when the cash is received.
Inventory. You have purchased raw materials or goods that have not yet been sold. The cash has been spent, but the costs only appear on the P&L when the goods are sold.
Purchase of fixed assets. If you buy a new machine for €20,000, the cash leaves immediately, but on the P&L, this expense appears gradually as depreciation over several years.
Loan repayments. Repaying a loan's principal reduces the cash balance but is not a P&L expense — only interest payments appear on the P&L.
To understand where the money has gone, you need to look at the cash flow statement.
The Cash Flow Statement — The Company's Lifeblood
The cash flow statement divides all cash movements into three categories:
Operating cash flow. Cash coming in from customers and cash going out to suppliers, employees, and in taxes. This is the most critical category — if operating cash flow is persistently negative, the company cannot sustain itself from its own operations.
Investing cash flow. Cash spent on acquiring long-term assets (equipment, property) and cash received from selling them. A negative investing cash flow in a growing company is normal — you are investing in the future.
Financing cash flow. Cash received from loans or investors, and cash paid out to repay borrowings, pay dividends, or buy back shares. A positive financing cash flow means the business is raising external capital.
Key Ratios Every Owner Should Track
Even if you don't understand the entire statement, follow these five key figures:
1. Current ratio. Current Assets / Current Liabilities. The ratio should be above 1.0 — ideally 1.2–2.0. If it falls below 1.0, the business may struggle to pay its bills over the coming year.
2. Receivable days. (Accounts Receivable / Net Turnover) × 365. Indicates how many days on average it takes for customers to settle invoices. If this figure is rising, your money is sitting with clients for increasingly longer periods.
3. Gross profit margin. (Gross Profit / Turnover) × 100. A margin decline of 2–3 percentage points can completely wipe out net profit.
4. Equity ratio. (Equity / Total Assets) × 100. A ratio below 30% signals heavy reliance on borrowed capital.
5. EBITDA. Earnings before interest, tax, depreciation, and amortisation. This figure approximately reflects the company's ability to generate cash from its core operations. It is frequently used by investors and banks when valuing a business.
Red Flags in Your Own Financial Statements
Learn to spot these warning signs:
Rapidly growing receivables without a corresponding increase in turnover. Clients are paying ever later, and you are becoming their bank.
Inventory growing faster than turnover. The company is producing or purchasing more than it can sell. Cash is frozen in the warehouse.
Current liabilities exceeding current assets. The company may be unable to meet its obligations in the near future.
Administrative expenses growing faster than turnover. The business is becoming increasingly inefficient.
Negative operating cash flow for three or more consecutive months. A serious warning, even if profit figures look good.
Reading financial statements is not difficult once you understand the basic principles. It is a skill that directly affects your ability to make sound business decisions — when to invest, when to cut costs, when to demand faster payment from a client. Our team helps entrepreneurs not only prepare these reports but also understand them — so you always know what the numbers are telling you about your business.
Last updated: May 2026. Information is based on the Law on Annual Financial Statements and Consolidated Financial Statements and International Financial Reporting Standards.
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