Welcome to part six in this series. In this sixth part of the series, we will be focused on reviewing the financial statements and we'll be covering the following three areas. 

First, we will recap the purpose of each of the three primary financial statements, what they show and how together they give a complete picture of the financial position and performance of the organisation. Second, we'll review how a director should read and interpret the financial statements and some questions they may want to ask. Finally, we'll consider some helpful financial ratios or metrics that directors can use to further analyse the financial statements and trends over time. 

We'll be referring to example financial statements for a fictitious company, Creative Arts Limited, and you can download a copy from the link in the video description. It will be helpful for you to have a copy of it available as we go through this session. If you haven't already watched videos three, four, and five in this series, I'd recommend you watch those videos first before watching this one. 

We'll begin with a recap of the three primary financial statements. The income statement shows how an organisation performed over a time period such as the financial year. It shows the revenue and expenses and whether the organisation made a surplus or a deficit. The balance sheet shows the financial position of an organisation at a point in time, such as the end of the financial year. It shows the assets, liabilities, and equity. The cash flow statement shows the inflows and outflows of cash in an organisation during a time period. It shows where the cash received came from and how it was spent. 

Three statements are interlinked and together provide a complete picture of the financial position and performance of the organisation. Let's look at how these statements work together in practice. Every year, the surplus or deficit in the income statement is transferred to the balance sheet and added to all previous surpluses and deficits to give the accumulated surplus or deficit number in the equity section of the balance sheet. 

In Creative Arts Limited's income statement, it made a surplus of $28,800 in the 2025 financial year. Now, taking a look at the balance sheet, the accumulated surplus at the end of 2024 was $325,300. Adding the 2025 surplus to this number gives the accumulated surplus at the end of 2025 of $354,100. 

The cashflow statement explains how the cash balance has moved over the period. Again, referring to Creative Arts Limited's balance sheet, the balance of cash at the end of 2024 is $344,000, and the balance at the end of 2025 is $198,200. These numbers correspond to the cash balances on the last line of the cashflow statement. To put it simply, the 2025 column in the cash flow statement explains the movement in the cash balance from 2024's balance to 2025's balance. 

We'll now turn to considering how we as directors should read and interpret the financial statements, individually and collectively. When reviewing financial statements, it is also very helpful to look for changes and trends over multiple periods or years. We'll start with the income statement and take you through a step-by-step process for reviewing it. 

Step one, review the different types of revenue. For example, ticket sales, grants, sponsorships, donations, or investment income. Then compare the actual revenue with the budgeted amounts. Do you understand the reasons for any large differences? The budgeted amounts will be found in the management accounts. Next, consider how diverse the revenue base is. Is there a risk that the organisation is too dependent on one type of revenue? For example, a grant, a donor, or an event, Creative Arts Limited has reasonable spread of revenue sources with $416,800 from performance revenue. In other words, ticket sales, and this represents 35% of total revenue. 32% of revenue is from fundraising and sponsorships, and 30% is from government grants. 

Step two, review the categories of expenses. Compare the actual expenses with the budget amounts, which are shown in the management accounts. Again, do you understand the reasons for any large differences? Then consider the types of expenditure is where the money is being spent aligned to the purpose and priorities of the organisation. Creative Arts Limited has a total expenses of $1,157,000, of which $600,800 or 52% is employee wages. 

Step three, did the organisation make a surplus or a deficit for the period? What has been the trend in surpluses or deficits over the past, say, five years? Creative Arts Limited's surplus has increased from $6,300 in 2024 to $28,800 in 2025. 

Next, we'll go through a step-by-step process for reviewing the balance sheet. Step one, are the assets of the organisation greater than the liabilities? In other words, does it have positive net assets or positive equity? Referring to Creative Arts Limited total assets of $842,700 less total liabilities of $472,200 gives net assets or total equity of $370,500. 

Step two, are current assets greater than current liabilities? Current assets or assets that are expected to be used or converted into cash in the next 12 months? Current liabilities are liabilities that are due to be paid in the next 12 months. You typically want current assets to be higher than current liabilities. Comparing the two is a helpful indicator of the organisation's ability to pay its liabilities when they're due. 

Total current assets of Creative Arts Limited are $239,400, which is actually lower than total current liabilities of $260,700. However, you can see that current liabilities includes revenues received in advance of $178,700, which is common in the balance sheet of many arts and cultural organisations. Creative Arts Limited has advanced ticket sales and government grants received in advance. 

Assuming the future performances are delivered and the activities required under the government grants are achieved, this money will be transferred and recognised as revenue as a consequence. It would be appropriate to ignore these liabilities when doing our comparison. For Creative Arts Limited, total current assets of $239,400 is higher than total current liabilities of $82,000 when we exclude the liabilities of advance ticket sales and grants received in advance. 

Step three, what is the level of net assets or equity, sometimes also called net reserves? Is there a sufficient financial buffer to cover future downturns in funding or to allow your organisation to take artistic risks? It is important that directors actively consider and agree a target level or target range of net reserves that their organisation should have. Their organisation should aim to build reserves over time to achieve or exceed this target. 

As a director of Creative Arts Limited, I'd be asking if core funding stopped tomorrow, how long could we continue to operate? A helpful benchmark for arts organisations is that unrestricted reserves should be at least 20% of annual expenses. For Creative Arts limited, this would be 20% of the total expenses of $1,157,000 or at least $231,400 in unrestricted reserves. 

However, if certain assets such as artworks or musical instruments are not easily convertible to cash, the directors may consider it necessary to set a higher target range. When calculating this ratio, restricted reserves are excluded as their use is restricted to a specific purpose. They're typically not available to use for general operating expenses. 

Turning now to the review of the cash flow statement. Step one, is the cash flow from operating activities positive? That is to say, is the revenue received in cash more than what is needed for day-to-day operating expenses? For Creative Arts Limited, net cash flow provided by operating activities was a positive $156,600. 

Step two, consider the cash flows from investing activities, that is the money spent on acquiring non-current assets. What assets is the organisation buying? Is it aligned to the organisation's purpose and priorities? Can this expenditure be funded sustainably? Creative Arts Limited spent $275,100 in the year on acquiring property, plant and equipment and financial investments. 

Step three, consider the closing cash balance and the movement during the period. Has the cash balance increased or decreased? Do we have enough cash on hand to pay employees, artists, and suppliers on time? Don't forget to consider timing differences between when income is received and when expenses are due to be paid. 

In the case of Creative Arts Limited, the balance of cash has reduced during the 2025 financial year by $145,800 to give a balance at the end of the year of $198,200. However, the value of financial investments has increased from $105,800 in 2024 to 374,500 in 2025, and these investments are likely also available to use to pay suppliers and employees, should this be required. 

Well now look at four helpful financial ratios you may want to consider calculating and tracking. A financial ratio is simply a way to compare two numbers in the financial statements and they assist you to spot trends quickly. For example, is a particular ratio better or worse this year than last. 

First operating margin, which is calculated as a net surplus divided by total revenue. In other words, what percentage of revenue is retained as a surplus after all expenses are accounted for? It's helpful to track this percentage over time to see whether the operations are becoming more or less efficient. Creative Arts Limited has operating margin of 0.6% in 2024, which improved a 2.4% in 2025. 

Second is revenue concentration. This is the largest revenue source divided by total revenue. As a general guide, if this number is greater than 40%, it may indicate that the organisation is overly reliant on one source of revenue, which may be a financial risk. In the case of Creative Arts Limited, the largest revenue source is performance revenue. That is revenue from ticket sales of $416,800, which is 35% of total revenue. 

Thirdly, artistic program expenses versus administration expenses. This is calculated as artistic program expenses divided by total expenses. For Creative Arts Limited, this ratio would be calculated based on detailed information provided in the management accounts. It may indicate that a disproportionate amount of money is being spent on administration of the organisation versus the artistic productions, and this may be misaligned with the expectations of stakeholders such as donors, government funders, or sponsors. 

Finally, fundraising efficiency expressed as a fundraising expenses divided by fundraising revenue, and again, as the name applies, it gives a guide as to the efficiency of fundraising activities. For Creative Arts Limited, this ratio would also be calculated based on detailed information provided in the management accounts. 

To summarise the key learnings from this part of the series, first we reviewed the purpose of each of the primary financial statements, what they tell you and how they're related. Second, we explained some step-by-step methods for reviewing the financial statements and examples of questions directors should ask to understand the financial position of their organisation. Finally, we provided some helpful additional financial ratios that directors can also use as an aid to tracking organisational financial performance over time.