As a business owner, you will be expected to produce three primary financial statements for each accounting period. Given that they each have a crucial role in tracking your company’s financial performance, you’ll need to be able to compare a balance sheet vs. an income statement and know what a cash flow statement is.
Whether you’ve just launched your business or want to play a more active role in handling your accounts and financial reporting, this guide will provide the info that you’ll need.
There are over 32.5 million businesses in the US, and they all need to satisfy their obligations for accurate financial reporting and accounting. Before looking at a balance sheet example or a sample income statement, you must first know what they are and how they function.
The basic definitions of the main types of financial statements are as follows:
While all financial reporting tools are used to determine where the company stands from a financial perspective, there are distinct contrasts in what they are used for. For example, balance sheets detail what the company owns and owes to see how effectively debt is used to leverage success.
Conversely, an income statement tracks both revenue and expenses to outline whether the company is operating in a way where income outweighs the outgoing expenses. A cash flow statement checks that capital is available. This is a crucial consideration since over a third of small businesses in the US claim they need more cash to operate better.
In other words, it’s not about the usefulness of a balance sheet vs. income statement accounts; it’s about using both of these financial tools together with cash flow statements to get a better picture of a company’s financial health.
Before learning how to read a balance sheet, you will need to know what is included on it and what each aspect relates to. Even if you use the best tax software on the market, this knowledge will be vital for extrapolating crucial information. A balance sheet will show your:
Recording all assets and liabilities and placing them into their categories, such as current and long-term assets/liabilities, will enable easy reading of the accounting balance sheet. Any such sheet will need to cover five key areas:
All current assets (highly liquid assets that can generate value within 12 months) should be listed in the first part of the balance sheet. Some of the items that may be listed in your account include:
The top of this list should include a “Total Current Assets” figure.
The second section should cover the long-term assets, which are low liquidity items that offer their value in a year or more. Some examples are:
The top of this section should include a “Total Long-Term Assets” figure.
The next section will list current liabilities, which are due within the next 12 months. Examples include:
A “Total Current Liabilities’ figure should be added to the top of this section.
Next up is the liabilities that are not due soon. This section should include the following:
The “Total Long-Term Liabilities” figure should be added too.
The final section of the balance sheet should detail the following:
With all of these sections completed, the balance sheet will be ready to file.
Any good Income statement example should give a clear insight into the financial performance of the company over a longer period. This is because it details both expenses and revenue. It will usually include the following data:
This figure is pretty self-explanatory and covers the revenue gained across all channels.
This refers to income that falls outside of revenue from sales. When added to the net sales, it should provide a “total revenue” figure.
After the revenue figures, the income statement will list the cost of producing goods, including related services.
Next, it will be necessary to detail the expenses not directly linked to your production costs. This can be followed by depreciation and amortization to gain a ‘total costs and expenses’ figure.
This figure comes directly after the total costs and expenses. It details the profits made through business operations after subtracting wages and depreciation.
This covers the company’s debt servicing cost and may be added to loss on extinguishment of debt. This cumulative figure is then subtracted from the operating income to show the pre-tax income, followed by a line to show the tax payment or benefit.
Finally, the net income will confirm the company’s profits or losses for the period in question. As with all figures in the financial reporting documents, a number displayed in brackets indicates a negative value.
Both documents can be very useful for your in-house financial management practices, and both will be scrutinized by accountants, investors, and partners. However, one of the main differences is that the income statement is dedicated to analyzing the company’s performance over a period of time, while a balance sheet looks at what the company currently possesses to confirm that it can meet its obligations.
It should also be noted that the income statement has to come before the balance sheet. You cannot work out the equity without first knowing whether your income outweighed the overheads or vice versa. The numbers detailed in the income statement will be included in the balance sheet, but it also adds assets and liabilities that were not covered in the income statement.
But while the income statement feeds into the balance sheet and contributes to the statement of the owner's equity, you should not fall into the trap of thinking that the latter is more important. Ultimately, it is the income statement that first shows whether the company is performing well or needs to address issues.
Likewise, this will be one of the most important features when considering expansions or major investments - because a company that isn’t already doing well shouldn’t be thinking about expansion.
As far as financial reporting is concerned, both the balance sheet and the income statement help explain the company’s financial standing. Understanding the relationship between an income statement and a balance sheet will put your company in a far stronger position.
When utilized well, they won’t just help you comply with legal obligations but also help the accounting process and facilitate making better decisions.
A balance shows Assets (balances, receivables, inventory, fixed assets, intangibles), Liabilities (payables, current liabilities, long-term liabilities), and Equity (net assets, capital invested, revenue).
All assets and liabilities should be added to the balance sheet, which can then be used to determine the equity. An income statement will detail sales, costs, gross profit, general costs, earnings before tax, net operating income, income and expenses, and net income.
While an argument could be made for either, the income statement is often the most significant financial statement for startups and SMEs because it analyzes the ability to make a profit.
While a company may record and file several financial statements, the most important documents are the Balance Sheet, Income Statement, and Cash Flow Statement. Between them, you’ll have a clear image of your financial performance. To understand these terms better, check out our detailed balance sheet vs. income statement comparison above.
Julia A. is a writer at SmallBizGenius.net. With experience in both finance and marketing industries, she enjoys staying up to date with the current economic affairs and writing opinion pieces on the state of small businesses in America. As an avid reader, she spends most of her time poring over history books, fantasy novels, and old classics. Tech, finance, and marketing are her passions, and she’s a frequent contributor at various small business blogs.
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