The income statement shows you how profitable your business is over a given time period. And the balance sheet gives you a snapshot of your assets and liabilities. Together, they’re a financial force to reckon with.
In the following guide, we’ll explore the role of these financial statements to show how useful they can be to your business.
An income statement (also called a profit and loss statement) tells you how much money your business made, and how much it spent, over a particular period. By going back and looking at trends in your income statements, you can track your financial health, and find ways to improve your profit margin or increase cash flow.
Income statements are prepared monthly, quarterly, and annually. However, they can be created for any time period you like. There are three steps to creating one:
By subtracting all your expenses from your revenues, you get your net income (also known as the bottom line.) This is the money you keep as profit.
Suppose Steam, a major game company, creates an annual income statement.
First they organize their revenue from the three types of games they make: First-person shooter (FPS) games, Real-Time Strategy (RTS) games and Role Playing Games (RPG).
The first part of the income statement would look like this:
| Category | Amount |
|---|---|
| Revenue from FPS | $50M |
| Revenue from RTS | $50M |
| Revenue from RPG | $50M |
| Total Revenues | $150M |
Once they’ve listed their total revenue, the accountants at Steam need to list their total expenses.
To do that, they add up amounts from all their expense categories:
| Category | Amount |
|---|---|
| Game development expenses for FPS | $30M |
| Game development expenses for RTS | $30M |
| Game development expenses for RPG | $30M |
| Hosting expenses | $2M |
| Delicious beef jerky | $5M |
| Total Expenses | $97M |
The accountants track expenses related directly to game development, plus other expenses they need to keep their business running. In this case, it’s beef jerky to feed hungry game developers.
Finally, with revenues and expenses accounted for, we calculate the net profit by subtracting expenses ($97M) from revenues ($150M):
Total profit: $53M
The income statement shows that Steam was able to earn $53 million dollars for the year.
Heads up: If your business uses the accrual method of accounting, your income statements report assets and expenses as they’re incurred, rather than when you actually earn or spend cash. In order to know how much cash you have to work with, you need to prepare cash flow statements.
The next financial statement, the balance sheet, helps tie together what the retained earnings mean to the overall value of the company.
The balance sheet tells you what you own, what you owe, and what’s left over. In other words, your company’s balance sheet shows you your current assets, current liabilities, and owner’s equity (or shareholders equity if you’re a corporation). That information tells you what your company is worth at a specific point in time.
Preparing a balance sheet is similar to preparing an income statement—with three major differences:
Listed before liabilities, the assets category includes both tangible assets (cash, inventory, real estate, company stock) and intangible assets (trademarks, patents, reputation, your client list).
Listed after assets, the liabilities category includes both short-term liabilities (money you need to pay back before the end of the the year) and long-term liabilities (money it will take you more than a year to pay off).
Continuing with the example from video game maker Steam, their asset categories are totaled and listed as follows:
| Category | Amount |
|---|---|
| Bank account | $80M |
| Accounts receivable | $2M |
| Computer equipment | $10M |
| Office building | $30M |
| Total assets | $132M |
Next, their liabilities and equity categories are totaled and listed as follows:
| Category | Amount |
|---|---|
| Accounts payable | $15M |
| Long-term debt | $40M |
| Total liabilities | $55M |
| Share capital | $20M |
| Retained earnings | $120M |
| Dividends | ($63M) |
| Total equity | $77M |
The information you can get about a company from both the income statement and balance sheet is useful. For example, Steam had a profitable year (from the income statement) and their assets outweigh their liabilities (from the balance sheet) which puts them in a strong financial position.
Further reading: How to Read (and Analyze) Financial Statements
This is just a brief example of the accounting dynamic duo in action. These two financial statements can do much more for a business. As a team, income statements and balance sheets work together to show just how well the company is performing, how much it is worth, and where there are opportunities to improve.
But financial statements are only as useful as the information you put in them—it’s essential to have accurate, up to date bookkeeping. Need a bookkeeper? Check out Accracy. We’ll do your bookkeeping for you, and give you simple, digital financial statements every month. Learn more.
We are offering free 1 Month Basic Bookkeeping to all new customers so you can experience Accracy's seemless and professional services.
The IRS can audit returns filed within the last three years—but there are exceptions that can extend this period up to six years and even longer.
Start categorizing your business expenses and help simplify your year-end list of tax deductions with examples.
W-9 is the form you use to send people your Taxpayer identification number (TIF). Here's how to fill it out properly.
