What is a Balance Sheet and Income Statement?
The terms balance sheet and income statement (or profit and loss statement) are widely used in the business sector. As a business owner or somebody who proposes to start a new business, you should be extremely familiar with these financial statements as understanding how to read your balance sheet and income statement is a basic necessity for knowing how your business is performing. In this article, we shall briefly give a comprehensive insight into what these financial statements are all about.
An income statement or profit and loss statement is typically prepared for a particular period i.e. between two dates. Ideally it is generated annually or for a period of twelve (12) months, but they can also be generated monthly, quarterly or six monthly. The particular period referred to above is termed as a financial period or financial year if for 12 months. The income statement tells you how much your business made and what it spent over the financial period. Comparing income statements of previous financial period one can also assess the financial health of a business and ways to improve profitability and control costs.
An income statement is a prepared to derive profit or loss for the financial period by comparing the revenues earned by the business with the expenditures incurred for the same period. By subtracting all your expenses (e.g. salaries, rents, purchases etc.) from the total revenues (sale of goods, sale of services etc.), you will derive the net income or popularly also called the bottom line. There could also be a net loss if your expenditures for the period overflow your revenues. Further, the income statement also includes expenditures that are amortized for more than one financial year e.g. depreciation or preliminary expenses to business formation or high value advertisement expenses, since the benefit of these expenditures are derived over more than one financial year. The net income derived after all expenditures being subtracted from total revenues is also referred to as profit before tax.
A balance sheet reflects what a business owns and what it owes. To elaborate, the balance sheet features the status or value of its assets (be it current or fixed) and liabilities (be it current or long term). The balance sheet also features the value of its Owner’s equity (a culmination of the capital introduced by the owner and the retained earnings/accumulated net incomes/losses). The assets typically include tangible items such as cash, inventory, debtors or accounts receivable, fixed assets like land, building, furniture, equipment etc., investments and intangible items such as trademarks, patent, goodwill etc. which the business owns at the end of a financial period. The liabilities on the other hand comprise current liabilities such as creditors for goods or expenses, duties and taxes payable at the end of the financial period as well as long term liabilities such as secured or unsecured borrowing from financial institutions or other lenders that are payable beyond more than one financial period.
At this point it is also important to understand that the choice of method of accounting also impacts how the balance sheet and income statement get reported. So there are two methods of accounting viz. Accrual method and Cash basis method. If your business adopts accrual method of accounting, your financial statements reflect incomes, expenses, assets or liabilities as and when they are deemed to be earned or incurred, whereas in case of cash basis method they are reported when actually earned or spent. In order to know how much cash your business actually has to work with, one needs to have their accountant prepare the cash flow statements.
So the information that you can draw from these two financial statements can be highly useful to business owners, CEOs, Founders, Directors, Finance heads, to evaluate the business performance and determine its financial strength. However, their usefulness entirely depends on how accurate the accounting and bookkeeping has been carried out. It is imperative to have precise and real time books in place in order generate meaningful financial statements. Need an accountant? Check out CharterCPA. We carry out your business accounting and help you generate timely and readable financial statements. We also help you with preparation of your tax compliances. Learn more.
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Knowledge Center Team
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