Balance sheet and income statements can reveal a lot about a company, particularly its assets, liabilities, stability, and solvency at a specific moment in time. It is a document for valuing a business worth and highly imperative for someone considering an investment opportunity. However, to make a solid conclusion, you must be able to read balance sheet and income statement and knowing important financial terminologies.
The balance sheet contains pertinent information, which gives a general understanding of a company’s solvency and business dealings. Usually, a balance sheet reports three things:
Asset – A list of monetary items owned and controlled by a business. It includes current assets and non-current assets. Current assets are easy to turn into cash within one year, such as cash in hand, prepaid expenses, inventory, marketable securities, account receivables, etc. Non-current assets include items whose face-value or true-value cannot be realized turn into cash within an accounting year, such as real estate, goodwill, patent, intellectual property, equipment, etc.
Liabilities – Liabilities are typically debt the company owes to a supplier, bank, lender, or other providers of goods, services, or loans. Liabilities are on the balance sheet under accounts payable, opposite to the asset section. There are two types of liabilities – current liabilities and non-current liabilities. Current liabilities refer to obligations payable within one year and sometimes include payroll, rent, utilities, account payables, and other accrued expenses. Non-current liabilities are long-term obligations or debts with payments not due until at least a year later. These long-term obligations can include a lease, long–term loans, bonds payable, deferred tax liabilities, and pension provision.
Owner’s equity – also known as the business net worth- displays the owner’s contribution/investment. Owners’ equity generally includes two key elements (a) Capital raised in the form of investment in exchange for some ratio of ownership and (b) Company earning.
Balance sheet ratios are short formulas you can use to assess your business’s financial health—just by looking at your balance sheet. They provide important insights into your business.
The income statement, also known as the profit & loss statement, gives an overview of the company’s expenses, source of revenue, overall profit, and loss incurred in a financial year. The income statements help in examining the financial performance more closely, i.e., whether the company is yielding a profit or not.
The income statement analysis starts with revenues. Is the company selling enough to make a profit and meet expenses?
This information helps decide the profit margin on goods & services and further creates a sales mix.
Last but not least, an income statement greatly helps determine General & Administrative expenses (G&A). Also known as the overhead cost, G&A is the expenses businesses pay monthly or yearly, such as rent, salaries, office supplies, utilities, etc. The general formula is:
Overhead Rate = Overhead Costs / Income From Sales
For example, let’s say your income from sales is $200000 with spending of $25000 in overhead costs. Hence, your overhead ratio is .125 or 12.5%. The lower the overhead costs, the higher your profit. This data further enables businesses to control certain expenses and adjustments to increase profits.
The balance sheet helps you to see if you have negative equity in the business, which is a sign that you’re either don’t have enough assets or you’re carrying too much debt.
The income statement on the other hand shows you how your expenses compares to your revenues. It also shows you if you have enough cash to make that big equipment purchase.
But you will not know any of these information if you don’t know how to read balance sheet and income statement.
You may also call us to discuss any tax problem , payroll reporting or business accounting issues you may have and we’ll let you know how we can help you.