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For many small business owners, reading – and understanding – a financial statement can be intimidating. Most entrepreneurs are not financial specialists, and it may seem like this is something that should be left to financial professionals, and for the line-item details, that’s true. But knowing how to identify 3 or 4 key items can give you important information at a glance about the health of your company. For example, a financial statement will tell you:

• If your company is making money, and if so, how much.
• If your company has debts, and if so, how capable it is to pay them back.
• How much your company spends to generate revenue.
• Whether your company is financially improving – or not – over time.

Sound important? It is, no matter what size your business is. So let’s get started!

The Balance Sheet

A balance sheet shows a snapshot of a company’s assets, liabilities and shareholder’s (owner's) equity at the end of the reporting period. (This is usually tracked monthly.)

The first component is what your company owns, which in turn determines the company’s value. It consists of 3 things.

1. Assets are things that your company owns that have value, like equipment, vehicles and inventory, and intangible things, like trademarks and patents. Assets also include cash and any investments the company makes.
2. Liabilities are the amount of money your company owes, and include loans, payroll and taxes. Fun fact: liabilities are generally listed based on their due dates, the shorter dates listed first.
3. Owner’s Equity represents the amount of money that would be left if all the assets were liquidated, and all liabilities (debt) paid. Owner’s Equity = Total Assets – Total Liabilities. This information is commonly used to determine your company’s financial health.

The Income Statement

An income statement shows your company’s incoming cash and outgoing cash over a period of time.

The income statement starts with the total amount of money brought in from sales of products or services (commonly referred to gross revenues or sales). Broadly speaking, the gross revenue is then reduced by expenses the company doesn’t expect to collect (e.g. discounts and returns) resulting in net revenue.

The subtraction process continues. Next you need to reduce the net revenue by the cost of sales – how much the company spent to produce what it sells. That's called cost of sales. 

Hang on. We’re almost there.

From that number, operating expenses and depreciation are subtracted, and voila; you see your income from operations. The next step is to add or subtract interest income and expenses to get your operating income before taxes.

The last piece of the pie is to subtract income taxes to see your net income or net loss.

You did it! There are lots of other fun reports, like Cash Flow, but we’ll save that for another time. And remember, if you ever have questions, we’re here to help you interpret and understand all of these financial tools, because the more you know about a company’s financial statement the better your financial conclusions and decisions will be.