The Purpose of a Balance Sheet and Income Statement
Financial statements such as balance sheets and income statements provide an overview of your business’s financial health. Banks, investors, employees and anyone else interested in a company can review these reports and see how much money is coming into and going out of the business, the types of expenses the business has, and whether or not the business is profitable. If you apply for a business loan or ask others to invest in your company, you’ll need a balance sheet and income statement to prove you’re a good investment risk. Balance sheets and income statements can also help you track the success of your business and spot potential problems.
A balance sheet shows your business’s assets, liabilities and shareholder equity at a specific moment. An asset is anything that has value, such as equipment, real estate or cash in your bank account. Liabilities are money you owe others, such as a mortgage on property and the balance of loans and debts to suppliers. Accrued taxes and payroll that you owe are also liabilities. Equity is the difference between the assets and liabilities – what would be leftover to repay original investors. In the case of a sole proprietorship, the equity would be the amount you, the owner, would receive if you sold all your assets and paid all your liabilities.
An income statement shows how much money the company made in a defined time period, such as last month, last quarter or last year. The statement starts with the money the company brought in and then subtracts the expenses associated with producing that income, such as the cost of supplies, payroll and office rental. This statement also subtracts expenses such as depreciation and any items that were returned. When all of the deductions are made, the result is the company's net income or net loss for the time period show on the statement.
Banks want to see balance sheets and income statements to determine if you’re earning enough to repay the loan you’re requesting. If you want to open an account with a vendor, they may ask to see these financial statements to verify that you’re making a profit, so the vendor is less likely to stuck with unpaid bills. Balance sheets and income statements can highlight trouble areas, such as chronic late payment fees for bills, or back taxes that you owe. If the income statement shows a high rate of returns, this could point to problems with your product that need to be addressed. While an occasional loss, especially in the early days of a business, may not be a concern, a string of losses after a period of profitability may mean you’re digging a financial hole you can’t climb out of without making drastic changes. A financial adviser or business mentor can review your financial statements with you and help you make wise decisions for your business.
Financial statements such as balance sheets and income statements are part of a whole package of documents you and investors can use to learn about a business. All the statements should be reviewed together, along with all related footnotes and the Management’s Discussion and Analysis section, in which company managers highlight industry trends and other information specific to their business which have affected or will affect company performance. All this information taken together can give you a more complete picture of a company’s current financial health and potential future performance.