Balance Sheet & Profit and Loss: A Beginner’s Guide

Marti DenUyl Accounting, Balance Sheet, Profit & Loss Statement Balance Sheet, Profit & Loss

If you’ve started your own business, you’ve likely come across two key financial reports: the Balance Sheet and the Profit and Loss Statement (also called the “Income Statement”). Although they might look similar at first glance, they serve different purposes. Let’s break down what each one tells you about your business.

What is a Balance Sheet?

A Balance Sheet provides a snapshot of a company’s financial position at a specific point in time. It shows:

What the business owns (called “assets”).
- Examples: Cash in the bank, equipment, inventory, property.
What the business owes (called “liabilities”).
- Examples: Loans and vendor bills to be paid.
The owner’s or shareholders’ share of the business (called “equity” or “owner’s equity”).
- Essentially, this is what’s left for the owners once all debts are paid.

Why it matters

The Balance Sheet answers questions such as:

Does the business have enough resources (like cash) to cover what it owes in the near future?
Is the company primarily funded through owners’ investment, or is it mostly financed by borrowing?

What is a Profit and Loss Statement?

A Profit and Loss Statement (often shortened to P&L) shows how much money a company makes (or loses) over a given period—like a month, quarter, or year. It typically includes:

Revenue or Sales
- Money earned from selling products or services.
Expenses
- Costs the business pays in order to operate, such as rent, salaries, utilities, and materials.
Profit (or Loss)
- If revenue is greater than expenses, the result is profit.
- If expenses exceed revenue, the result is a loss.

A Profit and Loss Statement shows a summary off all the money that came in and where it was spent. If there’s money left at the end, that’s your profit.

Why it matters

The P&L answers questions such as:

Is the business making enough sales to cover its expenses?
How much profit is being made over time?
Are costs too high?

Key Differences

Timeframe
- Balance Sheet: Shows a single date in time, referred to as a “As of Date” (like taking a picture of the company’s finances “As of ” 12/31/24).
- Profit and Loss Statement: Covers a period (such as January 1 to December 31) and tracks how money flows in and out.
Purpose
- Balance Sheet: Focuses on what a company owns and owes, and how much belongs to the owners.
- Profit and Loss Statement: Focuses on whether the company is making or losing money over a span of time.
Information Provided
- Balance Sheet: Good for judging financial stability, liquidity (how easily the company can meet short-term obligations), and overall net worth.
- Profit and Loss Statement: Good for understanding profitability and cost management.

Why Do Businesses Need Both?

Both statements complement each other, giving a well-rounded picture of the company’s health. For example:

You could be turning a profit (shown on the Profit and Loss Statement) but still have trouble paying bills on time if your Balance Sheet shows low cash and high debts.
Or you might have strong assets (like property or equipment on the Balance Sheet) but still lose money each month if expenses consistently exceed sales.

Understanding these two financial reports can help you see both the short-term and long-term status of a business.

If you’re just starting to learn about financial statements, begin with the main elements—assets, liabilities, equity for the Balance Sheet and revenue, expenses, profit/loss for the P&L. As you become comfortable with these basics, you’ll be able to use them to make informed decisions about your business or investments.

Looking to better understand the Balance Sheet? Check out our Beginner’s Guide for a clear and simple explanation. A Beginners Guide to Understanding the Balance Sheet

October 21 2023

Understanding Your Profit and Loss Statement: The Key to Knowing Whether Your Business Is Profitable

Marti DenUyl Accounting, Bookkeeping, Profit & Loss Statement, Profits Bookkeeping Help, Gross Profit, Net Profit, Operating Profit, Profit & Loss Statement

Have you ever wondered if your business is making money? The profit and loss statement (sometimes called the income statement) is one of the most important financial documents you can use to answer this question. If you’re not familiar with accounting, don’t worry. Below, I’ll break down the basics in clear, straightforward terms.

What Is a Profit and Loss Statement?

A profit and loss (P&L) statement shows you your business’s revenues (money coming in) and expenses (money going out) over a specific period—usually monthly, quarterly, or yearly. By subtracting your total expenses from your revenues, you can see if you made a profit (positive number) or a loss (negative number).

Why Is It Important?

Gauge Profitability:
The main point of the P&L is to determine if your business is profitable. Suppose the result is positive, great! If it’s negative, you know changes may be needed.
Plan for the Future:
Looking at your P&L over time helps you spot trends, like the most profitable months or quarters. This information can guide decisions such as when to invest in new equipment or when to focus on cost-cutting.
Benchmark Your Performance:
You can compare your business’s current performance to past periods or other companies in your industry. This helps you see if you’re improving or falling behind and make more informed business decisions.

Key Components of a P&L Statement

Revenues (or Sales):
This is the total income from selling goods or services. Keep clear records of all your sales so your P&L truly reflects your business activity.
Cost of Goods Sold (COGS):
Selling products includes the direct costs of making or acquiring them, such as materials and labor. Knowing your COGS helps determine your gross profit (sales minus COGS).
Operating Expenses:
These are the costs required to run your business, such as rent, utilities, advertising, and salaries for administrative staff. These expenses do not directly relate to making or buying what you sell but are necessary to keep things running.
Operating Profit:
Also called “income from operations,” this is your gross profit minus your operating expenses.
Net Profit (or Net Income):
After you add or subtract any other income (like interest earned) or expenses (like taxes), you arrive at your final net profit (or net loss). Net profit is the bottom line for your business’s profitability.
Do the Calculations:
- Gross Profit = Revenues – Cost of Goods Sold
- Operating Profit = Gross Profit – Operating Expenses
- Net Profit = Operating Profit – Other Expenses (like taxes)
Review the Final Number:
Compare net profit to previous periods or industry benchmarks. A healthy bottom line is the most straightforward indicator of success.

How to Use Your P&L Statement

Set Realistic Goals: If your profit is lower than expected, review your expenses to see where to cut back or increase efficiency.
Pinpoint Strengths and Weaknesses: If a particular product line is more profitable than others, shift resources to support it.
Stay Tax-Ready: Keeping a well-prepared P&L makes tax season less stressful and helps ensure you’re reporting accurately.
Seek Professional Advice: If you’re unsure about any part of your statement, don’t hesitate to consult an accountant or financial advisor.

Your profit and loss statement is a tool for understanding your business’s performance. Breaking down revenues and expenses into different categories provides a clear picture of your financial situation and helps you identify areas where you can cut costs or invest more.

Reviewing your P&L each month or quarter can help you spot potential issues before they become big problems. With these insights, you’ll be on your way to a more profitable business.