A comprehensive list outlining different types of financial statements can make James Joyce’s Ulysses seem like an easy summer beach read, by comparison.
Needless to say, the list can quickly become overwhelming for those without an accounting background. However, there are a few financial statements that every business professional needs to be familiar with, and more importantly, understand how to interpret and use. Two of the most important of these reports are the balance sheet and income statement.
In basic terms, a balance sheet shows a company’s assets and liabilities at a specific point in time, such as the last day of the year or month. Non-profit organizations call this a statement of financial position. In essence, it is a financial snapshot—at a specific point in time.
An income statement, on the other hand, presents the difference between a company’s revenues and expenses over a period of time. Often referred to as a P&L (short for profit and loss), the income statement, shows how you got there and gives you at least a sense of where you’re going. No matter what you call them, both are important for different reasons.
The snapshot of trees and landscapes in January will not tell the same story as a snapshot taken during the summer time for those of us living in the Southeast. What are the seasons of your business and how are they reflected in your financial statements? Have you stored up enough during the winter for what will be needed in the spring? How does this month’s story compare to last month, last year, what you expected? What do you need to store up for next winter and what are you doing about it today?
Think of financial statements in terms of your own personal finances. It’s the end of the month, and you see your bank balance is $1,000. Meanwhile, your remaining bills equal $100, leaving you with $900. This is your balance sheet. Suddenly, starting off the weekend with a nice steak dinner seems like a really good idea.
However, while logged into your online bank account, you decide to take a look at your transaction history over the past 3 months. Much to your chagrin, you see that during this time period your total withdrawals (i.e. expenses) are greater than your total deposits (i.e. income). This is your income statement. Now that steak dinner doesn’t seem like a great idea after all.
While both analogies are rather simplistic, they illustrate a key point—a balance sheet tells the current financial story of your company, while an income statement provides the context. Paying attention to both is crucial to the success of your business.