As a small business owner, you know that tracking the health of your business is critical.
In this article, we’ll discuss two of the most important financial statements for a business – the balance sheet and the income statement. We’ll examine how they are different and how others might look at the statements to determine the viability of your business.
First, let’s get the easy stuff out of the way, namely defining the difference between an income statement vs a balance sheet.
A balance sheet provides a snapshot of a firm’s financial position at a specific point in time, while an income statement – also known as a profit and loss statement – measures performance over a period of time.
In other words, if a large multinational company wants to buy your small business, they’ll want to know how you are doing today (balance sheet) as well as how you have performed over the last 12 months or 5 years (income statement).
Another way to look at it: an income statement lets you know that you are well capitalized for future financial storms, while a balance sheet tells you that you can pay vendors tomorrow.
Now let’s take a deep dive into each of these financial reports separately to understand them in detail.
The balance sheet provides an overview of the company’s financial situation at a specific time, and includes a business’ assets, liabilities, and owners’ or stockholders’ equity.
Assets might include cash, investments, prepaid expenses, accounts receivable, and inventory. Liabilities, on the other hand, are the total of your loans, wages and taxes due, accounts payable, and other debts. In short, liabilities include long- and short-term debt – what a company owes.
You can determine your company’s value by subtracting its liabilities from its assets.
A balance sheet allows a business owner to keep a close watch on the company’s financial situation. For instance, if a large number of liabilities are due in the coming month, a balance sheet allows a solopreneur to plan cash flows accordingly.
Once the balance sheet is complete, a small business owner can then perform an analysis of its various parts. One balance sheet analysis example is looking at your current assets vs non-current assets, or investments that are not expected to be converted to cash in the coming year, or those that are difficult to convert to cash.
In the same way, a solopreneur can analyze inventories vs receivables and the amount of cash on hand to fund daily operations.
An analysis of liabilities would consider current vs non-current liabilities (or those that don’t need to be paid within one year) along with equity, or the difference between the value of the asset and the debt attached to it.
Also known as a profit and loss statement (P&L), an income statement reports your small business’ revenue and expenses over a specific accounting period, whether monthly, quarterly, or annually.
If a company’s revenues and gains outrun its expenses and losses, then the company operates at a net profit. If the opposite is true, the income statement shows a net loss. That’s why financial institutions and investors are so focused on a given company’s quarterly reports. It shows, in black and white, whether the company turned a profit for the given period. This is also known as an income statement summary.
An income statement is separated into two parts called “the operating portion” and the “non-operating portion.”
The former is the part of your revenue and expenses that derive from your everyday business operations. For instance, the sales numbers of the products or services you sell versus the expenses incurred when creating those items.
The non-operating portion refers to expenses and revenues not part of your business’ regular operations. One example is the sale of a truck that was once used for deliveries. That would count as a non-recurring revenue item.
Both balance sheets and income statements provide important insights into your business operations. These two financial statements are also used by investors when they analyze the performance of a company. For the business, and the financial institutions that want your business, these two reports are invaluable in representing your company.