You know you need accurate information to make good business decisions. You have been using an accounting system and are able to generate reports. Your reports should provide you with the information you need but you are unsure if your numbers are accurate.
Two of the most common accounting reports are the balance sheet and the profit and loss statement (also known as the P&L or income statement). Knowing what to look for on these reports will help you determine how accurate your reports are.
What is a balance sheet?
Your balance sheet shows the financial position of your company as of a specific date.
A balance sheet is divided into three parts:
- Assets – Things you own. Examples of assets are cash, money in the bank, money owed to you (receivables), inventory, equipment, and other property.
- Liabilities – Things you owe. Examples of liabilities are money owed to others (payables), credit card debt, payroll taxes due, sales tax due, and loans.
- Equity – Your investment as the owner (or of owners if there are multiple owners). Examples of equity include stock, owner’s investment, and the value left in the business after the assets are used to pay off any outstanding liabilities.
Your balance sheet is important. If your balance sheet numbers are inaccurate, most likely your profit and loss statement numbers are as well.
Warning signs that your balance sheet is inaccurate
Warning signs often appear on the balance sheet that can indicate your numbers are inaccurate. These can be identified before digging into the details of specific accounts. Some common things to look for:
Assets – Are there any balances with a credit balance? Assets are not usually displayed as a negative number on your balance sheet. There are some accounts listed here however that we would expect to see negative balances for, such as any accumulated depreciation or accumulated amortization accounts. But most other asset accounts generally would not have a negative (or credit) balance.
Liabilities – Are there any balances with a debit balance? These would be displayed as a negative number on your balance sheet. Most liability accounts with a negative number are probably inaccurate.
Equity – Are there any accounts that do not seem that they should be in this area? The types of accounts that belong here are distributions or owner’s draw, shareholder or owner’s investment, retained earnings, and net income. Examples of accounts that shouldn’t be here are any receivable or payable accounts.
Paying attention to all warning signs will help you to identify many potential issues on your balance sheet.
What is a profit and loss statement?
Your profit and loss statement reports on how your business performed for a specific period of time. It reports the income, cost of goods sold, gross profit, expenses, net income, and other totals for the period of time covered by the report.
A profit and loss statement is divided into several sections:
- Income (or Revenue) – Fees earned from the sale of a product or from providing services
- Cost of Goods Sold – Direct costs related to the sale of the product or service
- Gross Profit – The net total of Income less Cost of Goods Sold
- Expenses – Indirect costs related to the primary operations of the business
- Net Operating Income – The net total of Gross Profit less Expenses
- Other Income – Revenue that is not related to the primary operations of the business
- Other Expense – Expenses that are not directly related to the primary operations of the business
- Net Income – The net total of Net Operating Income plus Other Income less Other Expense
Most business owners concentrate on the profit and loss statement. Your profit and loss statement, when accurate, will tell you if you are making a profit.
Warning signs that your profit and loss statement is inaccurate
There are warning signs indicating your profit and loss statement is inaccurate. Some common things to look for:
Income – Are there any balances with a debit balance? Most likely these would be displayed as a negative number on your profit and loss statement.
Cost of goods sold – Are there any balances with a credit balance? Most likely these would be displayed as a negative number on your profit and loss statement.
Expenses – Are there any balances with a credit balance? Most likely these would be displayed as a negative number on your profit and loss statement.
Be on the lookout for any accounts that do not belong on this report such as for owner’s draw, distributions, or loan payments.
Paying attention to all warning signs will help you to identify potential issues on your profit and loss statement.
If this sounds overwhelming or if you have discovered that there are problems with your numbers, there is no need to panic. You do not have to do this alone.
Reviewing for accuracy and cleaning up the bookkeeping is one of our specialties here at Beyond. In fact, we offer a checkup service that includes a review of your financial statement for accuracy. Learn more about this service and our other offerings on our Services page.