A tedious but important task you have to do as a business owner is keep your financial documents up to date. If you’re able to hire a bookkeeper or accountant, they can help make it easier by handling your important documents for you. But most businesses that are just starting out can’t afford accountants, so the owners then need to become literate when it comes to accounting and become familiar with the important documents.
The two key documents are the income statement and balance sheet, though there are more that come into play like the cash flow reports. So why are these documents important, and what is the difference between the income statement and balance sheet?
Why You Need Income Statements And Balance Sheets.
Both income statements and balance sheets offer a detailed look into how well a business is doing financially. Not only is the information listed on them important for tax purposes, but it will also be needed if you’re looking to finance your business through small business lending. According to the experts at Lantern Credit, “Year-end balance sheet for the last three years with a detailed debt schedule is required.” Lenders need to see the information both to determine what kind of credit risk they are, and determine whether or not they’re likely to pay back a loan. Potential investors also want to see that information to determine whether or not a business is a good investment.
What The Income Statement Is.
The income statement is also known as a profits and losses sheet, and it shows the revenue being generated, expenses and costs. The revenue is broken down into revenue that comes directly from sales, and revenue that may come from other non-sales activity. The expenses are broken down into operating expenses and overhead. Operating expenses are ongoing business expenses that would be things like inventory purchases, cost of business equipment, paying your employees, marketing, monthly loan payments and so on. Overhead expenses would be items like taxes owed, rent and utilities, legal fees, travel expenses and others. Your income statement will take the number of the total revenue it’s generating, and then subtract the total expenses number from it. If the result is a positive number, it means your business is operating at a net profit. If it’s negative, you’re operating at a net loss.
What The Balance Sheet Is.
The balance sheet can be a little more confusing because this deals with assets and liabilities, yet is calculated differently than an income statement. This is because the numbers take into account your total assets which are a combination of both equity in the business, and liabilities taken on by the business. Assets are basically arranged in terms of liquidity, or in other words the ability to sell them off. Cash on hand and accounts receivable invoices would be the most liquid assets, while business equipment, inventory and real estate would be less liquid. You can then break down which portion of those assets are a result of equity invested in the company, and which were purchased using debt. Equity could be your own capital that you used, or that of other partners or investors in the company, and then the earnings made from revenue that aren’t paid out. Liabilities are primarily debt financing instruments like loans, but they could entail a few of the expenses on your income statement. You basically add all of these up to see your total assets or net worth.
In conclusion, really diving into the income statement and balance sheet specifics can get quite technical, but there are courses and tutorials out there that help simplify it. You can even use inexpensive software to help tally all these numbers up and create statements needed to get a small business loan.