As a small business owner, there are many accounting terms to understand and documents to generate that help you run a successful business. Two of those documents are the profit and loss statement and the balance sheet.
You may generate these documents yourself or have your accountant do it for you. Either way, understanding what is in each report and what they show about your business is essential to your company’s financial health.
The Profit and Loss Statement Vs. the Balance Sheet
Profit and Loss Statement
The profit and loss statement is also called the income statement, or simply the “P&L.” This financial document contains your business revenues, costs, and expenses that occurred during a specific period, typically a month, quarter, or year.
The P&L starts with the revenue entry, also called the “top line.” The expenses, cost of goods sold (COGS), operating expenses, interest costs, taxes, and any other one-time expenses, are subtracted from the revenues. The “bottom line” is the profit or earnings, also called the net income.
The small business owner and potential investors can use the profit and loss statement to see if the business is profitable. You can compare prior P&L’s to the current report to see if the net income is increasing or decreasing over time and what factors are affecting the change.
The balance sheet provides a snapshot of how the business is performing at that particular time. The basic accounting formula used on the balance sheet is Liabilities + Shareholder (Owner) Equity = Assets. We call this financial document a balance sheet because both sides of the equation must balance out and equal each other.
An asset is anything the business owns that has monetary value, like cash, inventory, accounts receivable, vehicles, land, and other items with real value.
Debts are liabilities and can be current and long-term liabilities. A current liability may be a utility bill or vendor invoice. A long-term liability is a loan that you will pay off over several years, like a vehicle loan or mortgage. Accounts payable and payroll are also considered liabilities.
Equity refers to the value of ownership expressed in a dollar value. A single owner could hold the equity, as is the case with a sole proprietorship, or a combination of owners and investors if the business is structured like an LLC.
Once calculated, the assets in the balance sheet tell the story of your business’s health. A positive number shows good financial standing, while a negative number could mean the company is in trouble. Reviewing this statement regularly can help you realize and prevent potential economic issues before they become a big problem.
Which One Should I Use?
Both the profit and loss statement and balance sheet are essential documents for any business owner. The balance sheet provides a picture of the business’s financial health at any given moment and shows how much equity you have. The P&L shows the business’s profitability over time and if it’s operating in the black or red.
If you can’t or don’t want to prepare these financial statements yourself, it’s best to hire an accountant. And if you already have an accountant that isn’t providing them regularly, you should get one!
At JStevens Accounting in Annapolis, Maryland, we can help you with your Accounting needs, including providing regular financial statements. When it comes to understanding your business’s financial health, you should have an expert on your team. Contact us today for a consultation.