The two most important statements in business accounting are the Balance sheet and profit & loss statement (also called P&L, income statement or revenue statement). They have become crucial analytical tools for reviewing a company’s financial health when applying for a loan or looking for equity investments.
The primary difference between the profit and loss statement and the balance sheet involves their respective treatments of time. The balance sheet summarizes the financial position of a company for one specific point in time. The P&L statement shows revenues and expenses during a set period of time.
Profit and Loss statement
Your Profit & Loss Statement give you a picture of the net income of your business. That’s done by subtracting all your expenses from the total revenue you bring in. This is an important document that you’ll want to review more than once a year when you send documents to get your taxes prepared. Ideally, you should view it once a week if not once a month. Your P&L summarizes your business’s financial performance over different periods of time - daily, weekly, monthly, quarterly or annually.
1. In the left navigation bar, select Reports:
2. From the Report Center, you can either go to the Recommended tab or to All Reports > Business Overview, then choose Profit and Loss. (The Recommended tab is faster, but you’ll need to go to All Reports to get the Profit and Loss Detail). Just click on the report name or the link that says “Run” to open it.
3. Once it’s open, you can edit the date range, or click “Customize” to make other changes to the report. If you just change the date directly without clicking the customize button, make sure you click the “Run Report” button to view it with the new dates.
The Importance Of Profit And Loss Statements
P&Ls are very important. In fact, most businesses are required by law to complete them. But aside from obeying the rules, profit and loss statements give you the opportunity to review your net income, which is essential for making sound business decisions. You will also need a profit and loss statement if you plan to apply for a small business loan.
The complexity of these statements varies by business. While a sole proprietor might have a very straightforward and simple statement, a company with many employees, vendors, and expenses to record could have an extremely complex statement.
Confused by your profit and loss statement? If you don’t have a numbers background, the accounting jargon can be a little confusing at first. But once you learn the terminology, you’ll have a much better understanding of the information contained in these documents.
Important P&L Terms
Revenue: Obviously, revenue includes the total sales that you make, but it also includes money you receive from things like selling property and equipment or receiving a refund on your taxes.
Expenditures: It’s not difficult to figure out what information is contained on the total expenditure line, but there are specific types of expenditures you may not be familiar with.
COGS: This stands for cost of goods sold. Even though you might sell a cup of coffee for $3, you don’t make $3 from the sale. You should account for the cost of the materials and the time it takes to produce it.
OPEX: OPEX stands for operational expenditures. These expenses include any other costs associated with running your business that are not included in the cost of goods. For example: workers’ wages, travel, training, building leases, utilities, equipment purchase, hardware and software, advertising, cell phone and internet service. The list can get quite extensive, depending on the size and type of small business you operate.
Depreciation: You probably already know that if you drive a new car off the lot, it immediately loses some of its value. This is depreciation, and it doesn’t just apply to cars. Equipment, machinery and other business goods lose value over time as well, and this can be counted as a loss at tax time.
Profit: Profit is the proverbial “bottom line” on a profit and loss statement. It’s what’s left after you subtract all your expenses from your total revenue. And it’s probably the most important line for you. However, if you dig a little further, you’ll find there are different types of profit represented on your statement.
Gross Profit: This is the number you get when you subtract the cost of goods sold from your revenue. Business expenses like wages, utilities, rent, and more are paid from your business’s gross profit.
EBIT: This stands for earnings before interest and tax, and this number comes from subtracting both COGS and OPEX from your total revenue. The EBIT is a great indicator of business performance.
EBITDA: This acronym stands for earnings before interest, tax, depreciation and amortization. While this line can also be good for measuring profitability, the fact that it includes non-cash items (depreciation and amortization) means it doesn’t seriously impact your cash flow in the moment. It’s still important to understand, but probably not as useful to you in the grand scheme of things.
Knowing these terms and understanding the insights they provide can help you operate a more profitable business. Read your profit and loss statement regularly for signs that you are on the right track or for warnings that you might need to make some changes. Compare and contrast your most recent statements with past statements for a better picture of your current standings and to help make informed decisions in the future.
A balance sheet is a statement of the assets, liabilities, and equity of a business—essentially a “snapshot” of the value your business generates. This is done by subtracting your liabilities — what you owe to others, from your assets — cash, property, and what you’re owed by others. What you get is the equity, or what your company is worth. It’s useful for accountants to see your financial health and for banks when you are applying for loans. It’s also essential for the small business owner to get a true sense of how the business is doing.
Just as with a P&L, the standard balance sheet is fine, but I recommend pulling the balance sheet detail to send to your tax preparer or your business lender. As you can guess, it’s a more detailed version of the standard balance sheet, showing the starting balance at the beginning of last month, transactions entered in for the month, and ending balances.
To view the Balance Sheet, we’ll start the same way we did with the P&L.
1. In the left navigation bar, click Reports
2. From the Report Center, you can either go to the Recommended tab or to All Reports > Business Overview, then choose Balance Sheet. Recommended is faster for a standard Balance Sheet, but you’ll need to to All Reports to get the Balance Sheet Detail. Just click on the report name or the link that says “Run” to open it. If you hover over it, you’ll get a preview—this works for the P&L and other reports, too:
3. You can customize it before you view it, too. When you click the Customize button, QuickBooks Online will take you directly to the customization screen. This lets you choose your date range, along with some other options, like adding a column to compare to a prior period:
Your balance sheet gives you an at-a-glance picture of your company health. And if your company isn’t healthy, that’s not a good thing.
Think about it this way. Your balance sheet is the big picture view of what’s going on in your company. It’s called a balance sheet because it shows a balanced view of your assets, liabilities and equity.
A balance sheet as the name suggests should always be balanced. There’s a method to the madness and it’s based on a very simple formula.
Total Assets = Liabilities + Equity
Your balance sheet may have different components depending on how your books were set up initially, but the idea is still the same. Here’s a breakdown of the entries.
Let’s look at the assets section first.
Items that can easily be turned into cash are called current assets. In addition to the cash you have in your bank account, current assets also include those items that are cash equivalents like accounts receivable and inventory. Do not include in current assets cash that is restricted, or to be used to pay down a long-term liability.
Fixed assets include tangible items you use in your business, like your computer, to produce income for your company.
You may also have intangible assets. This includes things like your website domain, copyrights, trademarks, and business methods. These would be included beneath fixed assets on the balance sheet if they apply to your company.
For this section of your balance sheet, the most liquid assets are listed first, followed by less liquid items, in order of how easy it would be turn them into cash. The typical order is current assets, fixed assets, and then intangible assets.
That completes the asset side of your balance sheet.
Now let’s look at liabilities and equity.
Liabilities are obligations owed by the company.
Current liabilities include accounts payable and other short-term debts like taxes and loans, accrued expenses for which you have not received invoices, unearned revenue or advance payments received from customers for which work is yet to be done. Current liabilities are always paid with current assets, so it’s important to have enough assets to take care of liabilities. In general, a liability is classified as current when there is a reasonable expectation that the liability will come due within the next year, or within the operating cycle of the business. All other liabilities are to be classified as non-current.
A good rule of thumb is to have two and a half times more assets than liabilities.
Long term liabilities are obligations that will be paid in a term longer than one year.
Equity, also known as net worth, is determined by subtracting liabilities from assets.
How Your Balance Sheet Can Reveal Your Business Health
It’s important to remember that your balance sheet is just a snapshot in time. It’s a good idea to compare your current balance sheet with past reports to help shed light on what’s happening in your business.
Here are a few things to consider:
- Does your business have enough liquid assets to cover operating expenses?
- Do you have flexibility with your assets to allow for business changes (such as an unexpected expense)?
- Are your numbers trending in a certain direction (up or down) and what action can you take to correct the situation if needed?
- Can your current path be sustained to carry your business into the future?
To do that, you should run the report with a comparison to a past period. For example, if you wanted to see how you were doing this year compared to last year, your report might look like the sample below.
There are three important changes from last month to this month in this example.
- Your liquid assets (checking account) have increased, because
- You could collect on many of your receivables, and
- You paid down your credit card debt.
This report should be generated automatically by your accounting software. It’s a good idea for you to look at it regularly so you have a handle on your financial health and can use the information to help you make the right decisions to keep your business in a sustainable position.
The value of your assets minus your liabilities will result in an estimation of the value of your company’s capital. If this equation results in a negative net worth, this can be dangerous for a small business; it will make it difficult for to secure financing, which can be troubling for a company whose expenses are already eclipsing its profits.
If, however, a company has positive equity, this means that business owners have the option of acquiring capital by selling part of their business through equity, stocks and/or dividends.
In a sole proprietorship, this is called the “Owner’s Equity”; in a corporation, this is called “Stockholder’s Equity,” and it can include common stock, preferred stock, paid-in capital, retained earnings, etc.
“Equity” may include:
- Opening Balance Equity: The initial investment into the company
- Capital Stock: The common and preferred stock a company issues
- Dividends Paid: Profits paid out to shareholders by a company (applies to corporations)
- Owner’s Draw: Portion of the revenue used by company’s owner (applies to sole proprietorships)
Retained Earnings: The sum of a company’s consecutive earnings since it began
Now that you know what each of these reports are, and how to get to them, let’s recap what you’re looking at with each report:
Profit and Loss Statement
Summary of revenue, expenses, and profit or loss during a specific time period.
- Net Income (Profit or Loss for the period)
“Snapshot” of your company’s value, as of a specific date.
- Value of all assets
- Value of all liabilities
- Value of equity
- Net Income (from your P&L)