The Balance Sheet And Income Statement For Beginners

You might have unpleasant flashbacks of T accounts, journal transactions, and debit-credit theory if you took accounting courses in high school or college or browsed through other accounting books.

We could encounter some of that along the way, but today, we aim to turn those memories around with simple examples, explanations, and more—read on to find out everything about the balance sheet and the income statement.

The Balance Sheet And The Income Statement Explained

The two crucial financial statements you will rely on as a small business owner are your balance sheet and your income statement.

So let's get to it and see how things truly function using just one piece of paper. Imagine if Wafeq and other simple, effective accounting systems do not exist. We'll offer you one piece of paper to manage your firm instead. But we'll add a couple of headings to help you get started.

Balance Sheet: The Initial Outlay

Imagine that we are launching a web design company. We have SAR 5000 in personal startup money to get things started. It's wise to have a separate business bank account from your personal one for everything related to your business, regardless of the type of business you run. So let's immediately put our SAR 5000 startup money into our new business bank account.

What would we include in our one-sheet accounting system to reflect this?

Now that the company has SAR 5000 in the bank, we may enter that information under my company's Assets. Bank: SAR 5000

Additionally, we have no debts to anyone else, which indicates There must also be SAR 5000 left over for me. And we are aware that our initial investment was SAR 5000.

SAR 5000 is the owner's investment

Here it is in our notepad, written out:

Rent

The next step is to find a place to work and meet with clients. We chose to locate our business in a co-working space with a SAR 800 monthly cost because we are frugal.

Look at the page's right side. Since Rent is a cost, we will list it under "What my business spends":

Rent: SAR 800

Since we have yet to generate revenue, our company is currently in the red. Under "What's left for me," at the bottom to the right, we'll note that:

Earnings (Losses): SAR 800

Note: One approach to display a negative number is within parentheses, like in this example.

We paid the Rent on the left side using the funds in our business bank account. Therefore, we'll need to proceed and take SAR 800 out of that to reduce the amount to SAR 4,200.

As long as we keep in mind that our profit (or loss) on the right-hand side also belongs to us, "What's left for me" should likewise equal SAR 4,200 since we are still in the clear. So let's sum up and note:

How much I made: SAR 800.

Our page currently looks as follows:

Initial Purchase

We've put some money into the company, established an office, and have just made our first sale! Our first client has signed on the dotted line and delivered a SAR 3500 cheque.

Although it's enticing to hang your very first check as a keepsake, let's be responsible and deposit it in the bank instead! We'll deposit it in the bank, raising our current balance to SAR 7700.

Additionally, we can now add some income to the "What my business makes" area.

Sales: SAR 3500

This will also impact our profit or loss, as we witnessed when paying the Rent in Step 2, which will affect "What's left for me" on the left.

As you can see, everything about our accounts continues to make sense:

My Owner's Investment, plus what my business has made, less what it has spent, is what is left for me after subtracting what my business owes.

Credit Purchase

Five of the six headings have been used in our work. So let's do one more deal that takes advantage of the sixth. Let's imagine we hired a designer to create a logo for our new company. This work is performed locally, and we are invoiced SAR 500, payable within 30 days.

This is also a cost, so we'll list it under "What my business spends" on the right side of our notebook:

SAR 500 for design services

Every time we make or spend money, our profit changes, and that change is reflected at the bottom of the "What's left for me" section on the left. Additionally, we must mention that we paid for the logo design, but we still need to!

We have 30 days to pay our designer, unlike when we paid the bank for Rent. This means that we currently owe SAR 500 for our company. We can enter: Because this is a vendor "account" that we will pay later:

SAR 500 in accounts payable

The left side is now added once again. What's left for us is the difference between what the company has (SAR 7700 in the bank) and what it owes (SAR 500 in "Accounts Payable"): Our initial SAR 5000 investment and SAR 2200 profit total SAR 7200.

Enter The Income Statement

We've kept track of transactions under six sections on a single sheet of paper up until now. The two sides have been referred to as "What I have" and "What I earn," yet as you might have guessed, these two sides are used to create the balance sheet and the income statement.

Here's where we came to on the previous page, but with the words "accountant" instead of "company owner." Our "Balance Sheet" is shown on the left as follows:

• Assets = (what our business has) (what our company has)
• Liabilities = (what it owes to other people) (what it owes to other people)
• Owner's equity = what is still owed to us*
• Our "Income Statement" to the right displays = (what our business makes)
• Expenses = (what it spends) (what it spends)
• What's left for us, = profit or loss

Although a Balance Sheet and Income Statement may be produced using more detail by modern accounting software like Wafeq, this is essentially all that is available. If you've read thus far, you should now know how to read your financial accounts confidently.

*As you can see, we've also altered "What I've Earned" to "Retained Earnings" under Owner's Equity because that's what accountants term it.

FAQs

What is a balance sheet?

A balance sheet is a financial statement that summarizes a company's assets, liabilities, and shareholders' equity at a specific point in time, giving a snapshot of its financial condition.

What is an income statement?

An income statement, also known as a profit and loss statement, details a company's revenues and expenses over a specific period. It shows how the revenues are transformed into the net income or net profit.

How do a balance sheet and an income statement interact?

The balance sheet shows a company's financial status at the end of a period, while the income statement explains the changes in the net worth or equity of the company due to earnings or losses during the period.

Why are these statements important for small business owners?

These financial statements are crucial as they provide detailed information about the company's financial performance and health, aiding in decision-making and financial planning.

What are the main components of a balance sheet?

The main components include assets (what the company owns), liabilities (what the company owes), and shareholders' equity (the owner’s claim after subtracting liabilities from assets).

What can you learn from an income statement?

It provides insights into the company's ability to generate profit by detailing revenue sources and expense items. It helps in understanding efficiency, cost management, and profitability.

How often should these statements be prepared?

Typically, they are prepared annually and quarterly. However, small businesses may benefit from more frequent reports, like monthly, to better manage finances.

Can these financial statements help in securing loans?

Yes, these statements are critical when seeking financing, as lenders and investors want to assess the company's financial stability and profitability before making commitments.