A balance sheet details your company’s assets, liabilities, and shareholder equity at a specific time. An income statement shows what income is going in and what spending is going out, detailing a net profit or loss for a company.
What is a balance sheet?
A balance sheet is a financial statement of what a company owns, what it owes, and how much shareholders invest.
The balance sheet formula is:
Shareholders’ equity + Liabilities = Assets
It’s a general take on your company’s finances on a specific date. In a very literal sense, it’s made to show if your company is balanced. That is, it checks to ensure that your equity and liabilities do not outweigh the value of your assets. Its purpose is to showcase what assets are liquid, which is important if:
- You need to cover operational expenses
- There are unexpected expenses
- The company experiences business changes that need extra money
You’ll be able to see if liabilities are hurting your profits, meaning you’re operating at a loss, rather than a profit. While it’s important to look at your balance sheet for, say, a month or a quarter at a time, it’s important to compare it with other balance sheets. You could use other balance sheets from:
- Previous months or quarters
- The same months from previous years
- Competitors and businesses in the same industry
While the balance sheet is one of a few important financial statements, it’s not the only one that analysts and accountants will look it. Your company’s financial performance is also taken into account through the statement of cash flow and income statement.
What is an income statement?
An income statement is also a snapshot of a company’s financial performance. But it details income and spending, as well as net loss or profit, during a specific period. The income statement calculation goes like this:
Profit = Revenue – Expenses
Income statements are typically monthly but could showcase quarterly or annual profits (or loss). This can be month-to-month, quarterly, annually, or per month compared to years prior.
On an income statement, you’ll see:
- Income. These are things like sales, goods, and services sold to make money. It can also include fees or rent collected, if applicable.
- Expenses. This is what you’re spending money on. It could be operating expenses, debt, interest owed on top of that debt, and taxes.
- Net income (or loss): You’ll get net income by deducting your business expenses and operating costs from the total revenue. This includes deducting depreciation, interest, and taxes. If the number is positive, you’ve made a profit. If it’s negative, you’ve lost money, and there’s a chance you could be operating at a loss.
Sometimes these line items will have sub-items attached to them to showcase a specific detail. For instance, expenses might be broken down further to include operating expenses for things like equipment, marketing, and sales. And it can go even deeper than that, like if you want to include gross sales and net sales.
How you can use a balance sheet and income statement to get a clear financial picture of a business
When you apply for a business loan or an accountant checks your company’s financial health, they’re looking at three distinct things:
- Balance sheet
- Income statement
- Statement of cash flow
All of these will showcase how your company is performing in terms of profit and loss. They will also show how quickly you can handle a financial disaster through your liquid assets.
While not the same thing, both the balance sheet and income statement will be able to give you a clear picture of how to maximize your profit through:
- Liabilities. Which liabilities are causing the biggest unnecessary expenses? If you can cut down your liabilities, or your major expenses, you could increase your profit.
- Top performers. You’ll be able to see which assets are producing the most income. This may cause you to put more resources towards those top performers, and possibly eliminate those near the bottom of the list.
- Major financial decisions. With both statements, you’ll be able to see if you need to cut your losses, increase your resources in high-earning assets, or a mix of both. To increase cash flow, it might not always be one or the other.
If managed well, you’ll be able to get a clear and accurate picture of your company’s financial health. You’ll see spending and income broken down to see what’s working and what isn’t. The lower your liabilities, the higher your profits. The higher your profits, the more financial success you can have. Reviewing your balance sheet, income statement, and statement of cash flow are important to carefully keep tabs on your company’s financial well-being.
Monitoring your company’s financial success
The accomplishments of a company almost always come back to how much money it’s earned. Keeping track of how your business is performing financially is the biggest indicator of your company’s success.
If you’re operating at a loss, your company might be struggling, whereas if you have a profit — even a small one — that shows financial success. Using a balance sheet and income statement to detail where your money is coming in and going out will be your guide in either continuing what you’re doing or look for ways to improve.
If you aren’t sure how important these documents are, think about them when you need to borrow money. When taking out a business loan, lenders look at these statements to see the health of your company. It’s good for you to know how it’s doing before a lender does, that way you aren’t blindsided with results.
Increasing profits, building assets, and being able to cover emergency or unexpected costs are good financial goals for your company. Make sure you have a good team of accountants and financial analysts to lean on when trying to improve or capitalize on your profits. A smart team could be a difference-maker in your company’s success (or failure). Use them to understand your balance sheet, income statement, and other important financial documents to know where your company currently stands and projections for the future.
This article was originally written on October 21, 2019 and updated on October 28, 2019.