Maintaining accurate financial documents is of utmost importance for business owners. Of particular note are the Balance Sheet and Profit and Loss Statement.
Balance sheets provide an overview of what your company owns and owes at any one point in time, providing insight into its net worth. P&L Statements offer more in-depth analyses regarding revenues and expenses over a particular financial reporting period.
Assets on the left side of a balance sheet indicate what a company owns, such as cash, inventory, investments and any debt; liabilities such as accounts payable and deferred taxes appear on the right. Subtracting total assets from total liabilities and equity gives you an estimate of net worth for a business.
Companies typically divide their assets into current and noncurrent sections, with current assets representing those that can be turned into cash within one year, such as cash, accounts receivable and inventory. Noncurrent assets include patents and copyrights.
Investors and creditors use balance sheets as a gauge to evaluate a company, to make sure it can pay its short-term debts, that current assets exceed current liabilities, and is steadily adding shareholder equity over time.
Although liabilities often have a negative connotation, they’re an integral component of running any company. Liabilities encompass any money owed by a business to vendors, employees or suppliers and future investments – including long-term debt like bonds payable which typically tops off a balance sheet’s list.
Investors seek companies with more current assets than liabilities, and a rising owner’s equity. Accountants also document any contingent liabilities such as lawsuits pending in their financial statements in their footnotes.
Owner’s equity refers to the difference between a company’s assets and liabilities, including all money invested by investors as well as any retained earnings from profits.
Transportation/delivery companies that combine assets such as trucks, repair equipment and parking garage space with liabilities like vehicle loans, credit card debt, mortgage debt for their garage space and payroll have an owner equity of about $1.875,000.
Owner’s equity can be increased by recruiting additional partners or shareholders (capital contributions), increasing revenue through higher sales and reduced expenses, or withdrawing money from the company (withdrawals). It is listed on the left side of a balance sheet and also includes any treasury stock that shareholders have paid back into the company in order to acquire shares back from it.
Revenue in a balance sheet represents all the income that your company generated during a given period, without taking into account expenses such as payroll or rent payments. Think of revenue as being your top line.
Net Income is calculated by subtracting all costs and expenses from gross revenue over an accounting period, including material purchases, rent payments, insurance premiums, sales taxes and travel costs.
Services revenue can be determined by multiplying the total number of transactions (like forklift rentals) with their prices. You can also calculate accrued revenue, which refers to earnings a company had but did not realize immediately, such as interest on loans or deferred sales. Total revenue figures are often used by creditors and investors as an indication of financial health of a company.
If a company wants to remain financially healthy and viable, they must ensure their assets equal both debts and shareholders’ equity. To do this effectively, companies must maintain accurate balance sheets and profit and loss statements that show third parties the value of the business at any point in time.
Balance sheets provide only an overview, while P&L statements allow businesses to monitor progress over time. A growing P&L statement may signal expansion while declining ones could indicate trouble ahead. Furthermore, expenses should be carefully tracked in relation to revenue to prevent spiraling expenditures that become unmanageable over time.