In my last blog, we learned the answer to “Why are my business’s financial statements important?” They let you know exactly where your business stands. And you definitely need to see that at the end of each month. Our focus was on the Balance Sheet which shows you the assets of your business (what you own), the liabilities (what you owe), and owner’s equity (what you’d have left if you sold all your assets and paid all your liabilities).
This time, let’s take a closer look at the Income Statement. Remember the accounting equation: assets – liabilities = owner’s equity. For the Income Statement the equation is revenue – expenses = net income (or net profit). The basis of using this equation is that during a particular period, usually a month, a business should match its expenses with the income that is generated by spending that money. In accounting lingo, this is called the matching concept. From that, we see the obvious importance of this financial statement: which was greater for this month, my income or my “outgo”? That’s easy to see, just look at the bottom line of your Income Statement.
Now for the part that connects the income statement with the balance sheet: revenues increase Owner’s Equity and expenses decrease Owner’s Equity. When your business provides services or sells goods, the money your customers pay you is income. This income increases your assets (a deposit to your checking account, for example), but it also increases your owner’s equity. On the other side, when you write a check to pay rent or utilities or wages, you’re using up an asset to earn revenue. This decreases the balance of your checking account, but it also reduces your Owner’s Equity. So what you’re really looking at when you see the bottom line of your Income Statement is how much your Owner’s Equity has gone up since you earned a net income, “Yeah!,” (as opposed to a net loss which reduces your Owner’s Equity, “Boo!”).
In conclusion, knowing whether your month ends up with a net income or a net loss is vitally important in making decisions regarding business transactions that you will complete next month. Understanding these ideas about the Income Statement will help you make informed decisions.
You can go deeper in your understanding of your business financial statements by reviewing them with a CPA. There is value in having a professional go over your financial statements with you and offer recommendations to improve your business. Why not check out Jeffrey D. Reimer, CPA’s website at www.jreimercpa.com for a comprehensive view of services available to small business owners?