Your Financial Statements: What Every Entrepreneur Must Know
Posted by Pierre de la Fortune on August 16, 2015 @ 12:01 a.m.
Written by Guest Author
Your Two Major Financial Statements
There are two major financial statements that every entrepreneur should know how to read and (ideally) prepare or have prepared in their financial software (we recommend QuickBooks):
The Income Statement
The Income Statement (also known as the P&L or Profit and Loss Statement) offers a dynamic picture of the ebb and flow of your finances. Briefly, income statement shows first: A. Your various sources of income Then subtracts from that, B. Your expenses To give you the net result: Net Profit or Loss Typically, it is the result shown on this statement that is the basis for your taxation by state and federal authorities at the end of the year. The net income or loss (revenue outgo) is carried over onto your second major financial statement: The Balance Sheet.
The Balance Sheet
Offers you a snapshot of cumulative results of your financial activities. It is made up of two columns: On the left side you have your Assets On the right are listed your Liabilities and Owners/Shareholders Equity (or ownership in the business). The two columns must be in balance, which is why this is called a Balance Sheet.
It’s really quite logical how the Income Statement and Balance Sheet relate to one another.
If you have to use current or long-term assets to pay ongoing expenses during the current year, at the end of the year, the amount of your assets will be reduced by the amount of net loss. On the right hand side, your Equity has gone down too. If you borrowed, say $10,000 to pay current operating expenses, at year end, your assets remain the same, but your liabilities have increased by $10,000, lowering your net Equity or ownership in the company by that same $10,000. It doesn’t take a rocket scientist to figure out that if you continue on this path, you will quickly be in a very painful situation, because Liabilities carry their own cost. The cost of borrowing money is Interest, and if you are fortunate enough to borrow at only 10% interest (on unsecured debt) today, a year from now, you will have to pay $11,000 to pay off the original $10,000 debt. This reduces your equity still further–unless you have used the borrowed funds to create more assets that increase in value at the same rate as the interest on your debt or, better yet–at a higher rate.
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