How to Read An Income Statement And Balance Sheet
If you are a creative business owner, you have likely learned things over the years you never thought you would have had to encounter. Tax law, selling permits, and email funnel back ends are all tools of the entrepreneur that turns a small side hobby into a booming business.
One of the most helpful tools in your arsenal is your accounting – specifically, your financial statements. These reports tell the story of your business. They show what you value, where your income is coming from, how you are spending your time, and so much more. Two of the most valuable statements are your balance sheet and income statement (aka Profit and Loss Statement).
In this post, we will be discussing how to read an income statement and balance sheet. While helpful, they can also be very overwhelming if you are trying to decipher them for the first time.
Your income statement is generally made up of 3 sections. You have your income, cost of goods sold, and expenses.
Income is all the money you make from operations. This could be anything from product sales to affiliate income. All the money your business makes should be sent here. This is our baseline for the equation moving forward.
Cost of Goods Sold
The cost of goods sold will include any costs that go into creating the physical product or completing the sale. For example, if you sell paintings the paint, canvas, and labor that goes into creating the painting will be shown here and deducted from your income. These are also referred to as direct costs. They are directly associated with selling the product.
The expense category consists of indirect expenses or those expenses that support product sales. For example, bookkeeping labor would be an indirect expense. Your accountant is not directly putting together the widgets. However, the expense of paying your accountant is necessary to the business and thus, an indirect expense.
Have you ever heard someone say, ‘They are worried about the bottom line’ or ‘How will this affect our bottom line?’ When they say ‘bottom line’ they are referring to the last number that shows up on your Income Statement. This is the number that you get when you take your income and subtract the cost of goods sold and expenses. It is your profit.
There are a ton of different ways to analyze your income statement and the financial ratios that help you understand the numbers better. While important, simply understanding these basics can help you dramatically in your business. Instead, leave the details to your bookkeeper and meet with them regularly to take a deeper dive.
Just to make things a bit easier for you, your balance sheet also consists of 3 sections. Here you will find assets, liabilities, and stockholders’ equity. Your income statement will show what you made versus what you spent. While your balance sheet will show what assets you have and what liabilities you owe.
Assets consist of anything of value your business owns. This can include cash, inventory, equipment, property, and even trademark value. If it is providing a future benefit to your business, it’s an asset!