Learn to read income and balance statements by Jimmie Wilkins
Q. You talk about financial statements – please give me a primer. What should I look for?
A. You should be reviewing at least the two primary financial statements: the Income Statement and the Balance Sheet. Making business decisions based on your financial statements depends on being able to understand what they contain.
The Income Statement tells you if you made a profit or a loss for a specific accounting period, usually monthly (e.g. March 1 - 31, 2001). Some businesses may have them prepared quarterly but the best management decisions can be made if you are as current as possible. As a small business, you don’t have the “wiggle” room a larger business might and identifying any problem is better done sooner than later.
The Income Statement is designed to give you information about the accounts that fall in the categories of income, cost of goods, operating expenses and other income/expenses. The Income Statement shows what you made (income), what it cost you to make it (cost of goods sold) and what it cost you to just stay in business whether you had any customers at all (operating expenses).
Keep in mind that the Income Statement is not a cash flow and is not designed to keep you informed about the movement of money through your business. There are non-cash items (depreciation) on the statement and it does not reflect money you paid out for assets/liabilities (equipment or principal loan payments).
The very best use of an Income Statement is to compare actual income and expenses against a budget (sometimes called projections) you prepared at the beginning of the year and against last year’s performance. This will let you know if you are on target with both sales and expenses, if not – why not. This is where trends will reveal themselves and let you know if you need to make any changes in the operation of your business.
The Balance Sheet will tell you how you have managed the assets and liabilities of your business. It describes a specific point in time (e.g. March 30, 2001).
The Balance Sheet is one you may seldom examine if you don’t understand what it is telling you. The purpose of the Balance Sheet is to show you what the business owns, what it owes and what is the difference – its capital. It is designed to give you information about the accounts in your system that falls in the categories of assets (own), liabilities (owe) and capital (owner’s equity).
The very best use of the Balance Sheet is to watch the movement of the Capital/Equity account. This account tracks the amount of money/assets you initially put into the business (Owner Investment), the profit or loss from the Income Statement (Retained Earnings) and, in the case of a sole proprietor, the owner’s draws. Other critical aspects of the Balance Sheet are to track inventory trends, check debt to equity ratios and examine the liquidity of the business. (All skills you should start to learn about!)
Don’t just file away these critical management tools. Learn to read them!
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