Most business owners have a favorite financial report, and it is almost always the profit & loss statement. It is the one you check at the end of the month that feels like a report card. Whether you made money or not, you have an answer.
The trouble is that the profit & loss statement, reassuring as it can be, tells you only half the story. It shows performance over a stretch of time, which is truly useful. What it doesn’t tell you is just as important. It doesn’t tell you where your business actually stands right now. You find those answers on your balance sheet.
Each of these reports was built to do different jobs. Your profit & loss statement measures a period of time- a month, quarter, or year- showing you what came in against what went out. Your balance sheet lays out three things: what you own, what you owe, and what is left over for you.
What the Balance Sheet Tells You
Your balance sheet can tell you whether you can pay your bills.
A business can post a healthy profit and still struggle to cover payroll. Profit on paper is not the same as your bank account balance. Your accounts receivable (money customers owe you) is recorded on your balance sheet until the client pays you, but shows up as revenue on the P&L statement. Your balance sheet shows you what you own, what you owe, and the owner’s equity.
The balance sheet shows what you own.
Your current assets include cash, accounts receivable, inventory you plan to sell, prepaid expenses (e.g, insurance, rent, etc.), and any short-term investments. Non-current assets are long-term or fixed assets (items you hold onto and use over a fixed period of time). Together, current and non-current assets give you a total value of what your business owns.
The balance sheet shows what you owe.
Credit cards, loans, and unpaid vendors are short-term liabilities. Long-term liabilities include obligations that stretch beyond a year, like mortgages, equipment loans, long-term financing, and business lines of credit.
Owner’s Equity is also shown on your balance sheet.
Your owner’s equity is your total assets minus your total liabilities. The profit & loss resets every January and starts fresh. Your equity keeps score across the entire life of the company. Watching it climb year over year is one of the clearest signs your business is growing stronger, not just staying busy.
For example, a contractor felt she was having an excellent year. Her revenue was up, and her P&L statement proved it. Unfortunately, her bank balance remained low, which confused her. Looking at her balance sheet, she discovered that a significant portion of her income was billed but not yet paid by her clients. She also had a debt for an unexpected repair that needed to be addressed. Her P&L and Balance sheet were both accurate. However, she needed to review them both to get the total picture.
Both Financial Reports Are Equally Important
The Profit & Loss Statement answers a question every business owner needs answered. Is my business making money?
The balance sheet answers the questions about stability, staying power, and whether you can make it through a slow month without losing any sleep.
Begin a habit of reading both reports together. The P&L tells you how you performed, ed while the balance sheet tells you where you stand. Understanding both reports prevents guessing about your business’s health and lets you make decisions with facts in front of you.
If you’ve neglected your balance sheet while focusing solely on the profit & loss statement, now is the ideal time to re-examine how your business truly stands.
If you need help understanding your financial reports, contact Sarah at SAP Virtual Resources to learn more.