So you’ve set up your accounting system, you’re using your chart of accounts, and your books are up-to-date. Now what? It’s time to learn about financial statements!

While getting your system set up is a critical step, you also need to be able to get meaningful information out of it. Before we explore some of the more powerful reporting components of Accounting Data Standardization (ADS), let’s start with the basics and unpack the two primary financial statements: the Balance Sheet and Statement of Profit and Loss (P&L).

The Balance Sheet

The often-overlooked Balance Sheet provides valuable insight into the financial health of your company. It is a snapshot in time of your company’s financial position. The structure is as follows:

• Assets: Everything your company owns, listed in order of liquidity, or how quickly it can be converted to cash.
  • Current Assets: Cash, bank accounts, inventory, accounts receivable, and prepaid expenses. These items are expected to be turned into cash or used up within one year.
  • Other Assets: Equipment, buildings, and intangible assets. These assets will not be used up within one year.
• Liabilities: Everything your company owes, listed in order of how soon it will be paid out.
  • Current Liabilities: Accounts payable, credit cards, accrued expenses, and the current portion of long-term loans.
  • Long-Term Liabilities: Notes payable and bank loans.
• Owner’s Equity: Everything due to the owners of the company. This section has specific accounts depending on the entity’s structure (corporation, partnership, sole proprietor), but will have the following:
  • Capital: Funds invested into the business by the owners, less any draws.
  • Retained Earnings: All of the accumulated net income of the company since inception, less any dividends paid out to date.

The Balance Sheet is an important tool for assessing the health of your business. It helps answer questions such:

• Do I have enough cash to cover my loans that are due?
• Has this business given me a return on my investment?
• Am I holding onto too much cash?
• Do I have the capacity to take advantage of a loan?

The Balance Sheet though is only one side of the coin. It shows where you are but not how you got here. To get a different perspective on your company’s financial health, take a look at the Statement of Profit and Loss.

The Profit/Loss Statement

Whereas the Balance Sheet is a snapshot in time of your company’s financial health, the P&L is a movie, covering a range of time. It answers the question: what have we accomplished? The P&L provides you with insight about your company’s sources of income. It also allows you to evaluate your expenses to determine if you are using your financial resources effectively.

At the most basic level, the P&L comprises of four sections and four key totals or subtotals:

• Income: In this section, income is listed by category, allowing you to see how much income each group of products or services are generating. 
• Subtotal: Total Income: This shows all of your income before any costs are considered.
• Cost of Goods: This lists the direct costs associated with the products and services being sold. These costs include the cost of inventory and production staff wages. Ideally, the categories of costs will mirror the categories of income, but this is not always available.
• Subtotal: Gross Profit: This subtotal shows the profit remaining after subtracting the direct costs from total income. This amount is important to pay attention to because it indicates how much money is left over from your sales to cover the overhead costs of your business. Monitoring this number can help you to evaluate your sales prices and cost of supplies.
• Operating Expenses: These are the other costs associated with running your business, such as advertising, administration, and office expenses, among others. As with the other sections of the P&L, expenses are listed by category. Having subtotals for similar expenses can make the expense information more meaningful, allowing you to quickly assess your company’s expenses while still having sufficient detail for analysis. 
• Subtotal: Net Operating Income: This shows net income from operations before considering any non-operating items. Reviewing net income before adding other items is helpful to get a more accurate picture of your company’s performance.
• Other Income/Expense: Some items are considered income or expense, but are not directly related to your business operations. These include interest and miscellaneous income/expense.
• Subtotal: Net Income/Loss: Total income minus all costs and expenses results in net income or loss. This amount is what is left for the owners after all income and expense sources are considered. If it is a positive amount, it is net income and it increases Retained Earnings on the Balance Sheet. If it is negative, it decreases Retained Earnings.

Reviewing these financial statements is important as you steer your business. They should generate questions which lead you to take an honest look at how your business is running.

In additiont to these financial statements, there are other important tools that will help you get even more insight out of your financial data, such as looking at key ratios, benchmarking, and trend analysis (stay tuned for these!). The more tools you have, the better you are able run your business. So let’s keep learning how to use these tools!