Understanding income statements and balance sheets are a necessary function of running a successful small business. Financial statements refer to your income statement (also referred to as your profit and loss or P&L), balance sheet, and cash flow statement. Financial statements provide you with the ability to understand a critical part of your business’s performance.
An income statement is the one financial statement that most small business owners understand. It provides you with a view of how much revenue the business has generated, how much the company has spent on expenses and cost of goods, and the difference (profit or loss) between them. The income statement is typically run for a specific time frame (often monthly, quarterly, and annually) so the business owner can understand how the business is performing. The income statement compares your revenue and expenses to determine how much money you have made or lost in its most basic format. The income statement calculation is:
Net Income = Revenue – Expenses
The income statement may come in different formats based on the type of business you own. If your business is service-based, you will usually have a very basic income statement that shows revenue, general and administrative expenses (or G&A), and net income. However, suppose you own a business that is a distributor of products or a manufacturer. In that case, your income statement will have an additional category for your expenses called cost of goods (or COGS). The reason is that these businesses need to understand the gross profit they generate, which is calculated as:
Gross Profit = Revenue – COGS
Therefore, the net income calculation becomes:
Net Income = Revenue – COGS – G&A
Finally, some businesses like to separate their interest expense associate with loans to see what is referred to as their operating profit. In this case, the operating profit is calculated the same way we discussed, except for the interest expense separated from the G&A expenses.
Operating Profit = Revenue – COGS – G&A
Net Income = Operating Profit – Interest Expense
No matter how detailed you want your income statement to evaluate how your business is performing, the bottom line is always the same. It would be best if you generated more revenue than all of your expenses to be profitable.
All financial accounting systems can create financial statements. Once you have the format of your income statement setup, your bookkeeper or account will prepare your income statements monthly, quarterly, and annually so you can review how your business is performing. This process is typically automated by your accounting system and will determine and reveal your net income, aka profit.
The balance sheet provides you with an overview of your assets, liabilities, and owners’ equity. The easiest way to think of the balance sheet is to tell you how much your business is financially worth. The formula for the balance sheet is:
Equity = Assets – Liabilities
You always want to have your assets growing faster than your expenses so that your equity increases. That’s a good thing! This can get a bit more complicated if you are a manufacturer and buy equipment, but it’s pretty straightforward for a service-based business or distributor. Setting up your balance sheet is critical and should be done with your accountant. As you start to review your balance sheet, you will see a few extremely important components to check. One of these is your accounts receivable or how much money your customers owe you. The other one is your accounts payable, which shows you how much money you owe to your supplies/vendors.
Often referred to as a statement of financial position, your company’s balance sheet displays a summary of all your business assets, listed individually and with monetary totals. Then, your liabilities are listed separately and with monetary sums. Literally, the bottom line of your balance sheet will present your total equity.
A cash flow statement shows the business owner the amount of cash coming into the business and how much cash is leaving the company. This should not be confused with the income statement. If you are running a business on the accrual accounting method, you can generate profit, but cash flow may not keep up. The best example of this is when you bill your customers and record the income, but they are slow to pay you. You may see this in the cash flow statement where cash has not come into the business, but the revenue was recorded.
As you can see, each of these financial reports provides you with different information that is important to understand how your business is performing. Are you making money but struggling with cash flow? Do you have cash flow, but your liabilities are growing? With a solid financial management team, your business can grow and be successful.
Getting started with understanding your financial reports begins with making sure your reports are current and accurate. You need more than a bookkeeper to perform financial tasks. We want you to be successful, and we know what it takes to do that. Time spent on bookkeeping and financial tasks requires both time and knowledge. Hire Carly, and we will do the bookkeeping for you. Then you can return to spending time on building your business!
Expex, based in Schenectady, NY, offers convenient and innovative bookkeeping services to help your business succeed. Our application, Carly, can do everything a traditional bookkeeper does and more. This financial management program expertly delivers services such as bill payments, bank and credit card reconciliation, and financial records consolidation. Call (518) 389-2305 today to get started, or contact us to learn more about Carly.