Aside from keeping the IRS and your bank happy, there are numerous reasons to keep track of the financial statements related to the operation of your business. These can range from helping you price your products, tracking the margins between your costs and revenues, and giving you a continuous insight into how, and which way, things are going. Tip: It’s easier to keep up with these if you have accounting software (here’s a list of some).
Really, the name says it all. A balance sheet looks at the equation Liabilities + Owner’s Equity = Assets and hopes to find it equal (or balanced). An easy way to remember the difference between assets and liabilities is through the old saying, “Assets put cash in your pocket; liabilities take cash out of your pockets.”
The two types of assets on a balance sheet
- Current Assets, which are those expected to be sold or otherwise used up in the near future, usually within one year, or one business cycle (whichever is longer). These include cash, short-term invests, receivables, inventory and prepaid expenses.
- And Fixed Assets, which are those purchased for continued and long-term use. They include land, buildings, machinery, furniture, tools, and certain wasting resources (e.g., timberland and minerals).
The two types of liabilities on a balance sheet
- Short-Term, which can be expected to be liquidated within a year—wages, taxes, accounts, accounts payable, etc.
- And Long-Term, which cannot be expected to be liquidated within a year—mortgage loans, business loans, long-term bonds, etc.
Profit and loss statement
Also referred to as a P&L or “income statement,” a profit and loss statement allows you to see a snapshot of what the financial state of your company is at a specific point in time. To calculate, use the equation Net Profit = (Gross Profit – Operating Expenses). Note that gross profit is calculated by total profit minus the cost of goods sold, which includes raw materials, inventory and payroll taxes. (Another term for gross profit is “after cost of goods sold”)
Cash flow statement
This statement simply shows how much money is going into and out of your business at a specific point in time. This is like the cash in a person bank account–it’s focused on the cash you actually have in your possession. Calculate this figure with the equation (Beginning Cash Balance + Cash Inflows) – Cash Outflows = Ending Cash Balance. Cash inflows include cash payments, accounts receivable collections or cash from other sources. Cash outflows are equipment purchased, expenses paid, inventory, overhead and other payments.