The Two Financial Reports Every Small Business Owner Should Understand

Running a small business means making decisions every day: what to spend, what to charge, whether you can afford new equipment, when to hire, and whether the business is actually making money.

To help you understand the financial health of your company, there are two reports every small business owner should become familiar with: the Profit & Loss Statement (also sometimes called the Income Statement) and the Balance Sheet. Together, these reports give you a much clearer picture of how your business is doing.

1. The Profit & Loss Statement

The Profit & Loss Statement (P&L) tells you whether your business made or lost money during a specific period of time.

That period might be:

• One month

• One quarter

• An entire year

Your P&L shows your income, the costs associated with earning that income, and your operating expenses.

Your income section shows the money your business earned from sales or services. If your business has costs directly associated with providing those goods or services, those are shown as Cost of Goods Sold or Cost of Services. Subtracting those direct costs from your income gives you your gross profit.

Your expense section shows the costs of running the business, such as payroll, utilities, rent, office supplies, insurance, and loan interest.

After expenses are subtracted, you can see whether the business had a net profit or net loss for that period.

What should you look for?

Do not just look at the number at the bottom of the report.

Pay attention to:

• Whether revenue is increasing or decreasing

• Which expenses are taking up the largest portion of your income

• Expenses that have increased unexpectedly

• Whether your profit margin is improving or shrinking

• How the current month compares with previous months or the same period last year

For example, your sales may have increased significantly, but if your expenses increased even faster, your business may actually be less profitable.

2. The Balance Sheet

The Balance Sheet gives you a snapshot of your business's financial position at a specific point in time.

While the Profit & Loss Statement tells you what happened over a period of time, the Balance Sheet tells you where your business stands on a particular date.

The Balance Sheet is divided into three main sections: Assets, Liabilities, and Equity.

Assets

These are things the business owns or amounts owed to the business.

Examples may include:

• Cash in bank accounts

• Accounts receivable

• Equipment

• Vehicles

• Inventory

Liabilities

These are amounts the business owes.

Examples may include:

• Credit card balances

• Business loans

• Accounts payable

• Payroll liabilities

• Sales tax or other taxes owed

Equity

Equity represents the owner's financial interest in the business.

• Which needs to stay in the positive. If your equity goes into the negative then that will raise a red flag at tax time. (High credit card balances lead to negative equity.)

Why You Need Both Reports

One of the biggest mistakes a business owner can make is assuming that money in the bank equals profit.

It does not.

Your bank account tells you how much cash you have available today, but it does not tell you the whole financial story.

For example, your business might have $20,000 in the bank, but you may also have upcoming bills, credit card balances, and taxes that still need to be paid.

On the other hand, your Profit & Loss Statement might show that your business earned a healthy profit even though your bank balance is temporarily low.

That is why reviewing both reports is important.

The Profit & Loss Statement helps answer:

“Is my business making money?”

The Balance Sheet helps answer:

“What is the financial position of my business right now?”

Your Financial Reports Should Help You Make Decisions

Financial reports should not simply be something your bookkeeper sends you every month that gets filed away and forgotten.

They are tools.

Reviewing your Profit & Loss Statement and Balance Sheet regularly can help you make better decisions about:

• Pricing

• Spending

• Taking on debt

• Purchasing equipment

• Saving for taxes

• Managing cash

• Planning for growth

  
  

You do not need to know how to prepare financial statements yourself. That is part of what a good bookkeeper is there to help with. But as a business owner, learning to read and understand these two reports can give you more confidence when making financial decisions for your business.

Good bookkeeping is not just about keeping accurate records. It is about turning those records into information you can actually use to run a healthier business.