As a small business owner, the buck stops with you. Whether you own a one-person shop or something larger, everything rides on your shoulders. There’s also a lot you need to handle that you didn’t sign up for — including small business accounting. The good news is that accounting doesn’t need to be complicated.
There are three basic financial statements — written records that show your business activities and financial performance.
These statements are essential if you are ever audited by a government agency or a bank wants to evaluate your business before issuing a loan.
Financial statements help you file your taxes, gauge your business health and show potential investors how your venture is doing.
Editor’s note: Don’t have a business website yet? Launch one today with our 30-day risk-free trial. Includes all you need to promote your product or service widely, plus step-by-step advice to guide you.
3 essential financial statements
There are three types of financial statement that every small business should prepare at least once each year:
- Balance Sheet.
- Income Statement.
- Cash Flow Statement.
In addition to explaining each of these three statements, we’ll offer 5 financial best practices to keep your business in shape.
1. Balance Sheet
The balance sheet shows the financial health of a business at a single moment in time.
A balance sheet is a snapshot of how your business is doing.
This financial statement will help you make crucial decisions such as:
- How much inventory you should order
- Whether you need the cash infusion of a loan
- If there are assets you should sell
What’s in a simple balance sheet
It is a two-sided chart that shows your Assets in one column and your Liabilities and Equity in the other.
It’s called a balance sheet because the totals in each column must be equal. If the numbers don’t match, something is wrong with your calculations.
Every balance sheet is based on this formula:
Assets = Liabilities + Equity
Assets are what your business owns, which could include:
- Inventory (products ready to sell)
- Equipment
- Vehicles
- Furniture
- Property you own
- Cash
Liabilities are money owed by your business, such as:
- Short-term debts
- Long-term business loans
- Accounts payable
The difference between your assets and liabilities is equity: how much you and your investors would have left over if the business sold its assets and paid off what it owes.
Get start-to-finish instructions on creating a balance sheet here — including links to balance sheet templates.
2. Income Statement
An income statement is a report that captures your revenues, costs and expenses over a set period of time.
This document shows your bottom line, so it’s the document you would show potential lenders like a bank or investors. It’s also important in tax season, as your taxes are calculated based on your net income.
Your income statement is based on this formula:
Net Income = (Revenues + Gains) - (Expenses + Losses)
The breakdown
An income statement has four sections:
Revenues
Your gross (total) sales minus your returns equal your net sales.
Cost of goods sold
Cost of goods sold considers the cost of:
- Buying inventory
- Freight
- Direct labor involved in making goods
- Indirect expenses
The following formula will give you your gross profit (or loss), typically presented between brackets.
Expenses
These are expenses not directly related to acquiring inventory or making goods. They include things like:
- Wages
- Advertising
- Depreciation
- Payroll taxes
- Office expenses
- Utilities
This also includes amortization, an accounting technique that spreads the cost of an intangible asset such as a patent or franchise agreement out over its useful life.
Other income
If your business has sold any assets or earned interest on loans or investments, it may have other income that’s not related to your business’s primary activities. This section can result in either a gain or loss. For example, you may see a loss if you sell an asset for less than what you paid for it.
The final result of these four sections — revenue + other income - cost of goods sold + expenses — is your net income or net loss.
Two accounting methods
When you are creating your income statement, you will have to decide between accrual accounting and cash accounting.
Accrual accounting puts money owing and money owed (accounts payable and accounts receivable) on your income statement when you earn it, i.e. when the transaction occurs. This is a good choice for any business with inventory as well as those that sell on credit.
With the cash accounting method, you wait until your customer pays or you pay up on your accounts. The cash accounting method can provide unique insights into your business, but it can also leave you open to oversights, such as missing problems with your collections process. The method works better for a small, cash-based business or service company.
The easiest way to start creating an income statement is with a template like this one.
Related: Save money with these small business accounting tricks
3. Cash Flow Statement
A cash flow statement shows how money comes in and how it goes out.
Potential investors will want to see this report.
Whereas your income statement shows your company’s bottom line, this document gives you a better idea of how your business earns cash and where it goes.
There are three activities documented in a cash flow statement:
Operations
This includes both money spent and earned on your business operations, including your accounts receivable, accounts payable, wages, merchandise expenses, etc.
Investments
You can track the money spent on investments such as new equipment or making a loan, as well as money made from selling assets or collecting interest payments.
Financing
Your cash flow statement also reflects new inflows such as:
- Bank loans
- New money from shareholders
- New investments from yourself
All are recorded here, along with dividend payments, loan repayments and activities like selling company stock.
Use this cash flow statement example to get started.
Best practices for small businesses
Think your business is too small to need financial statements? Think again.
Even one-person businesses can benefit from a few good habits.
Basic accounting helps you achieve your business goals and stay on track. Here are a few tips:
Prepare a budget
Making a budget helps you set reasonable business goals. Even an estimate of how much you need to operate for the year ahead makes a big difference in confident decision-making.
Separate personal and business finances
Having a separate credit card for business expenses will make your life much easier when it comes time to prepare your finances. You might also be able to get a kick-back or earn points faster with a business credit card.
Plan your investments
Every time you buy something for your business, make sure it’s part of your plan. Evaluate every purchase based on how it will help you reach the goals you’ve set.
Keep up with your bills
As a small business owner, you know how frustrating it is not getting paid on time. Paying your bills in a timely manner can help you build better relationships with suppliers and improve your credit rating.
Create a separate bank account for taxes
If there’s one thing you can count on in the unpredictable life of an entrepreneur, it’s paying taxes. You can make it easier on yourself by collecting sales taxes in a separate account. When it’s time to pay them, they’re ready to go.
Master the basics and win
It’s not hard to make your life as an entrepreneur easier. Learn about financial statements, use templates to generate your balance sheet, income statement, and cash flow statements and put these best practices to use.
