Income statements and balance sheets are reliable ways to measure the financial health of your business. Click below to download a free sample template of each of these important financial statements.
Your income statement and balance sheet are two of the most important documents you will create as a business owner. Not only can they can show you how your business is doing financially, they can even help you project how it may perform in the future.
Wondering what information you should include on an income statement or balance sheet? Keep reading for suggestions about the types of data you can include on each of these financial statements.
Things that You’ll See on the Balance Sheet
A balance sheet is a snapshot of your company’s net worth at a given point in time. Specifically, it measures a business’ assets minus its liabilities. In other words, a balance sheet can show you what your company owns and how much it owes.
On a typical balance sheet, you’ll find a detailed list of financial information broken down into three sections — assets, liabilities, and net worth.
The term assets describes anything of value that your business owns. Assets can generally be cashed out, sold, or used to create things (e.g. products or services) that can be sold.
When you open a new balance sheet template, start by listing your current assets first (typically on the left-hand side of the spreadsheet). Ideally, you should add business assets to your balance sheet in the order in which they could be liquidated.
Your current assets might include any of the following items (along with its value):
- Cash Balance in the Bank
- Petty Cash
- Accounts Receivable
- Equipment and Machinery
- Real Estate Owned
- Prepaid Expenses
Your company might possess intangible assets as well. Intangible assets often include intellectual property such as trademarks, patents, copyrights, licensing agreements, customer lists, or even your brand itself.
However, intangible assets aren’t always included on balance sheets. Those included may need to have a specific value that can be assigned (such as the cost of purchasing that intellectual property from another company).
Liabilities is a term that describes your business’ financial obligations or the money it owes to others. Often, these may be divided into short-term (or current) liabilities and long-term debt.
For financial reporting purposes, short-term financial obligations are usually due within one year or less. Meanwhile long-term liabilities have a due date that’s further away.
Your company’s short-term liabilities might include:
- Rent and Utilities
- Invoices Due to Vendors and Suppliers (aka Accounts Payable)
- Salary and Wages Payable
- Shareholder Notes Payable
- Income Taxes Payable
- Short-Term Loans
Long-term business liabilities might include:
- Long-Term Loans
- Deferred Taxes
- Bonds Payable
Even though long-term liabilities aren’t due until some time in the future, they’re still included on your business’ balance sheet. But long-term debts may be viewed differently by lenders and investors alike. They typically signify less financial risk than short-term debt and liabilities.
Lenders and investors may focus more on a business’ short-term liabilities versus its assets. These figures on a balance sheet can be used to help predict whether a company has the cash flow it needs to keep operating at a successful level. If it looks like a company won’t have enough assets to cover its short-term liabilities, it could be a sign of financial problems on the horizon.
3) Net Worth
At the bottom of your balance sheet template you’ll have the chance to subtract your company’s liabilities from its assets. The figure you’re left with is the net worth of your business.
Here’s a look at the accounting equation you can use to calculate net worth.
Assets – Liabilities = Net Worth
Sometimes net worth is referred to as the owner’s equity, stockholders’ equity, or shareholders’ equity. Yet there’s actually a slight difference between these terms.
- Net worth usually refers to the overall value of a business.
- Equity is the portion of the company’s assets left over after its debts and liabilities are paid.
- Owner’s equity or shareholders’ equity describes the value that an individual or group holds in a business.
Balancing Your Balance Sheet
When you’re done calculating the figures on your balance sheet template, you can tell if you completed the statement correctly by using the following equation.
Assets = Liabilities + Owner’s or Shareholders’ Equity
In other words, the two sides of your balance sheet (assets and liabilities + equity) should be equal to each other. Here’s a simple example to illustrate how your balance sheet template might look once you’ve completed it.
|Assets||Liabilities and Equity|
As you can see, the left side of the balance sheet shows what the company’s assets are worth. The right side of the balance statement shows how those assets are currently being used. If the total on the left side of your balance sheet doesn’t equal the total on the right (and vice versa), there’s an accounting error somewhere in your report that needs to be corrected.
Things that You’ll See on the Income Statement
An income statement is another helpful tool you can use to track the financial wellbeing of your company. This type of statement is often referred to as a profit and loss statement. It can help you and potential investors figure out whether your business is currently earning or losing money — and how much of it.
It’s worth noting that your company’s income statement will only consider income and expenses for a specific period of time. Depending upon the type of report you create, you can measure your company’s profit and loss over a month, a quarter, or a year (or some other time frame if desired).
“Revenue and expenses are the key items of an income statement. A small business would break down revenue and expenses in more detail to better understand sources of revenue and the cost of producing that revenue” says Jo-Ann Yuen, a Chartered Accountant with 20+ years experience with multinational corporations and start-ups and the VP of Finance for Nav. “While it is good to know if the business is making a profit in total, it is also important to understand if each major source of revenue also contributes to overall profitability. If one revenue source is actually subsidizing another revenue source, you would want to know that and take corrective action.”
On a typical income statement, you’ll also find a detailed list of financial information broken down into three sections — income, expenses, and net profit or loss.
You can include any money that makes its way into your business checking account during the specified period of time on your company income statement. These funds might come from your business’ primary operations (i.e. the goods or services it sells) or from other sources. Generally, you should list all income sources at the top of the statement.
A few potential revenue sources you might include in your income statement include:
- Sales of Products or Services (aka Revenue Earned)
- Interest Earned
- Affiliate Commissions
- Rent Payments Received
It’s fine to total individual deposits into groups for reporting purposes. You might, for example, receive affiliate commissions from several different companies. Instead of listing each deposit separately, you could add these similar sources of revenue together and record the total amount on a single line on your report.
Next, you’ll want to add company expenses to your income statement. These will cover any times that money made its way out of your business checking account during the specified time frame of the report you’re creating.
Potential expenses might include:
- Costs of Goods and Services (Materials, Labor, Storage, Depreciation of Equipment, etc.)
- Operating Costs (Wages and Salaries, Rent, Utilities, Marketing, etc.)
- Taxes Paid
- Interest on Loans and Credit Cards
- Miscellaneous Cash Outflow
Again, you’ll research each debit or withdrawal from your account separately. However, it’s fine to combine similar expenses together, such as operating costs, and include them as one entry on your actual income statement.
3) Net Profit or Loss
At the bottom of your income statement, you’ll calculate your company’s net profit or loss for the time frame of the report. For example, if your income statement covers the past year, this section of your report will show how much money your business made or lost during that time. This figure is often referred to as your business’ bottom line.
To tally net profit, you can use the following basic formula:
Total Income Earned (Revenues) – Total Expenses = Net Profit (or Loss)
How Are the Income Statement and Balance Sheet Related?
It’s true that your income statement and balance sheet track different aspects of your business’ financial health. Nonetheless, these two financial statements are closely related. When a figure changes on one report, it often impacts a related figure on the other.
Below are three common ways that your company’s income statement and balance sheet might influence the other.
- Your company’s assets will generally improve its income, if managed well.
- The liabilities your company owes usually increase business expenses.
- The more revenue your company earns, the higher its overall net worth may climb.
None of the statements above are set in stone, of course. But they do represent several common connections between income statements and balance sheets that many companies experience.
Why Income Statements and Balance Sheets Matter
You should create (or pay someone to create) income statements and balance sheets for your company regularly. In fact, if your company is publicly traded, financial reporting is required by the Securities and Exchange Commission (SEC).
When you apply for a business loan, the lender may request a copy of your income statement and balance sheet (among other documents) as part of the application. Lenders use these statements, along with your business credit scores and other information, to assess the risk of loaning your company money. If your income statement and balance sheet each show a company that’s thriving financially, your odds of being approved for new financing could improve.
You can also use income statements and balance sheets to evaluate your company’s financial success over time. For example, when you compare last year’s balance sheet to this year’s report, you can gain additional perspective into the growth or decline of your business.
Tracking Business Goals
As a business owner, filling out reports might not be your favorite thing to do. But it’s an important part of helping your company succeed.
Your overall goal should be to acquire and/or build company assets. At the same time, you should aim to decrease company liabilities. Together, this can potentially be a recipe for a more profitable business.
Keep in mind, there’s often a place for debt in business as well. It’s just important to take on debt wisely and with a specific purpose in mind. For example, you might borrow money with the goal of increasing company income, expanding, or acquiring assets.
Unrestricted borrowing or taking on more debt than you can afford isn’t a wise move. However, taking out a loan with a goal of growing your business may have the potential to pay off in the end — perhaps in a big way.
Remember, income statements and balance sheets are tools you can use to measure your progress toward important business goals. Analyzing these financial statements can also help you discover if you’re getting off track early so you have the chance to make a quick course correction before the problem gets out of hand.