While business owners often think of financial statements as being primarily relevant from a tax compliance and liability perspective, financial statements such as the balance sheet and income statement can provide users with information that is particularly helpful when making particular business decisions.
Which statement will be the most helpful will always depend on the decision you're facing and the type of information you need to make the assessments that will help you choose from among the potential options and solutions.
Unlike the income statement, the balance sheet shows financial statement users a business's financial position at a specific point in time. It is based on what's known as the accounting, or balance sheet, equation: Assets = Liabilities + Owner's (or Shareholders') Equity.
So, what goes on a balance sheet? The following are a balance sheet's main components:
- Assets. A business's assets are the resources it owns that help it to run and operate the business. On the balance sheet, assets are divided into current assets, such as inventory and accounts receivable, and fixed or long-term assets, such as buildings and intellectual property.
- Liabilities. Liabilities refer to a business's debt obligations. Like assets, they are categorized as either current or long-term. Current liabilities include accounts payable, while long-term liabilities are those debts that will not come due for a year or longer.
- Owner's equity or shareholders' equity. This component refers to the equity put into a business by owners or shareholders, along with retained earnings, which are funds that have been reinvested into the business.
Rather than showing a business's financial performance at a particular point in time, the income statement tracks revenue and expenses over a specific reporting period, such as a quarter or a year. Income statements can be presented in either of two formats, single-step or multi-step:
- Single-step income statement. A single-step format is an option that's available to businesses with simpler business structures, such as sole proprietorships and partnerships. The single-step format focuses on a business's net income, and often the revenue and gains and the expenses and losses are shown on a single line each. However, more detail can be provided through a breakdown of revenue and expenses.
- Multi-step income statement. Corporations are generally required to file income statements that use the more detailed multi-step format. Unlike the single-step format, a multi-step income statement provides users with the business's net income and its gross profit and operating income figures. The in-depth information presented in the multi-step format makes it more useful for potential investors or creditors that assess the financial health of a business.
Which statement should you use?
Depending on the information you require for decision-making purposes, you'll find either the balance sheet or the income statement more useful.
For example, while the balance sheet will provide users with information about a business's financial health at a specific point in time, it can also calculate a business's debt/equity ratio.
On the other hand, an income statement tells users how profitable a business has been over a specific period of time. For example, a potential creditor would find the income statement useful in determining whether a business will be able to handle projected debt payments for specific amounts of credit.
Consolidated financial statements, such as a consolidated balance sheet, can also be useful when dealing with a parent company's financial health and its subsidiaries.
However, partial income statements show either a small portion of a reporting period or highlight only one element of a typical income statement and will usually not provide sufficient information for the financial statement user.
It's important to know the options you have when it comes to examining your small business's financial data and performance. If you have any questions as you complete your financial statements or annual report (if your state requires one), consult with an attorney or financial professional or hire a compliance specialist who has expertise in the areas you need assistance.