Understanding Financial Statements

Balance sheets and income statements are checks that tell you about the health of your business and are used to keep track of your finances. They are used to manage your operations and provide information that you and your accountant may need to make important financial decisions and formulate effective business strategies.

A balance sheet tells you about the net worth of your business at any given point in time. It includes information on your assets or your worth in declining order of liquidity (the commitment, liabilities or money you owe others) and the owner’s equity (the amount of money that actually belongs to the owner of the company). Capital assets, such as the value of buildings or property and equipment are also included.

An income statement can also be referred to as a profit and loss statement or simply a P&L sheet. It reports on the income made versus the expenses incurred over a specific period of time. The problem with drafting this sheet is in attributing certain costs to specific periods of time and incorporating the depreciating value of various fixed assets, such as equipment and other property.

The balance sheet and income statement are bound together by a formula: the equity at the beginning of the balance sheet added to the profit or loss incurred from the income statement equals the equity for that period.