The two main statements are the balance sheet and the income statement. In broad terms, the first shows what you have, while the second shows how you got it.
Confession: I don’t much like the grunt work it takes to produce good statements. Its hard work, and I’ve put it off once or twice. But I love what good statements can do for a company. Thus, I encourage you to stay on it, and include an accountant to help you set them up right. Now back to the story…
Balance Sheet – This shows all the assets (money and stuff) that your company has to work with at any given point in time. The basic equation for a balance sheet is:
Assets = Liabilities + Owner Equity
In other words:
Assets = What the company has today
Liabilities = What the company owes (debt)
Owner Equity = What the company is worth
It goes without saying that a healthy, growing organization gets to see an increase in assets and owner equity from year to year. A particularly savvy one will even eliminate the “liabilities,” making it almost unshakable in adverse conditions.
How do you tell if a company is making progress toward that goal? A big part of the answer to that question is the:
Income Statement – This shows a company’s profitability. It is also referred to as the Profit/Loss Statement. If the balance sheet shows how far you’ve traveled, the income statement shows how fast your motor is turning to get you there.
The income statement is my favorite. It starts at the top with Net Sales for a given period, and then subtracts expenses until the “bottom line” shows profit or loss. Thus, the equation for the income statement is:
Sales – Costs & Expenses = Income
In other words:
Sales = Everything sold during a given period
Costs = Direct costs of producing products sold
Expenses = Other money spent in the period, like selling expenses and utilities
Income = What’s left over (profit!)
Now let’s sample the magic that comes with good financial statements, using a simple example:
Imagine Farmer Brown sells a case of honey for $14. Without good accounting, he may not know it took $15 to produce it. Obviously he’s losing money on the deal.
BUT, if Farmer Brown figures out his costs, and can sell it for $16, he makes a $1 profit. (I promised this wasn’t complicated =) If he can sell it for $17, he makes $2 profit (double!) on each sale.
If Farmer Brown’s miscellaneous expenses are $20,000, he needs to sell 10,000 cases at $17 to break even. If he increases the price to $18, he makes $3 per case, resulting in a $10,000 profit on 10,000 cases after covering the $20,000 in expenses.
In this case, what’s the difference between great success and financial ruin? About $4.