Updated August 2026
Your financial statements should tell you more than whether you made money last month.
A good Income Statement can show you whether margins are shrinking, expenses are creeping up, or increased sales are actually translating into increased profit. Your Balance Sheet answers a different set of questions: How much cash does the business have? How much debt? What does it own? What does it owe?
You don’t need to be an accountant to use these reports. But you do need to know what you’re looking at. Here are the basics of the two financial statements every business owner should understand—and, more importantly, how to use them.
Income Statement
The Income Statement, also called a Profit and Loss Statement or P&L, shows how your business performed over a specific period of time.
You can run an Income Statement for a month, quarter, year, or another period. It shows your revenue and expenses and, ultimately, whether the business made a profit.
Revenue
Revenue, or sales, is the income your business earns from selling goods or services.
If you own a coffee shop, for example, the money earned from selling coffee, sandwiches, pastries, and bags of coffee beans would all be included in revenue. Revenue tells you how much the business sold. It doesn’t tell you how much of that money you actually kept.
That’s where the rest of the Income Statement comes in.
Cost of Goods Sold
Cost of Goods Sold, or COGS, includes the direct costs associated with the products or services you sell.
For a coffee shop, this could include coffee beans, milk, cups, lids, food ingredients, and other supplies that go directly into the products being sold.
COGS varies considerably by industry. A retailer, contractor, restaurant, and professional service firm will have very different cost structures.
Gross Profit
Subtract Cost of Goods Sold from Revenue and you get Gross Profit.
Revenue – Cost of Goods Sold = Gross Profit
Gross Profit is an important number, but the percentage can tell you even more.
If your business has $500,000 in revenue and $300,000 in COGS, your Gross Profit is $200,000 and your Gross Profit Percentage is 40%. Watching that percentage over time can help you spot problems. If sales are increasing but your Gross Profit Percentage is falling, ask why. Have material costs increased? Are you discounting more often? Have your prices failed to keep up with costs?
A business can increase sales and still become less profitable.
Operating Expenses
Operating Expenses are the other costs involved in running the business. Depending on the business, these might include:
- Payroll
- Rent
- Insurance
- Advertising and marketing
- Office expenses
- Professional fees
- Utilities
- Auto expenses
- Software and subscriptions
One useful exercise is to compare each major expense category to the same period last year.
An expense increasing isn’t automatically a problem. You may have hired another employee, expanded your location, or increased advertising intentionally. The important question is whether you know why the expense changed and whether you’re getting enough value from the additional spending.
Net Income
After your business expenses are subtracted from revenue, you’re left with Net Income, or Net Profit. This is your bottom line.
There isn’t one “good” Net Profit Percentage that applies to every business. Healthy margins vary considerably depending on industry, business model, size, and stage of growth.
Instead of relying on one generic percentage, compare your results to:
- Prior years
- Your budget or projections
- Similar businesses in your industry
- Your own profitability goals
If revenue increased 15% but Net Income stayed the same—or went down—that deserves a closer look.
How to Use Your Income Statement
Don’t just run an Income Statement at tax time.
One of the simplest ways to use it is to compare the current period to the same period last year. Look at Revenue, Gross Profit, major Operating Expenses, and Net Income.
Then ask: What changed? Why did it change? Is that change good for the business?
Be careful about drawing conclusions from a single month, particularly if you use cash basis accounting. The timing of deposits and large payments can make one month look unusually good or unusually bad.
Quarterly and year-to-date comparisons will often give you a better picture.
Consistency helps too. If possible, process income and large vendor payments consistently around the end of each reporting period so your comparisons are meaningful.
Balance Sheet
While the Income Statement tells you what happened over a period of time, the Balance Sheet shows where your business stands at a particular point in time. It is built around a simple equation:
Assets = Liabilities + Equity
The Balance Sheet shows what the business owns, what it owes, and the owner’s equity in the business.
Assets
Assets are things the business owns or controls that have value.
Depending on your business, they may include:
- Cash in bank accounts
- Accounts Receivable
- Inventory
- Equipment
- Vehicles
- Real estate
Cash is particularly important because a profitable business can still run into trouble if it doesn’t have enough cash available to meet its obligations.
Liabilities
Liabilities are amounts the business owes.
These may include:
- Credit card balances
- Accounts Payable
- Payroll and sales tax liabilities
- Vehicle loans
- Equipment loans
- Lines of credit
- Mortgages
- Loans from owners or other parties
Debt isn’t automatically bad. Borrowing can help a business buy equipment, expand, acquire property, or manage cash flow.
The question is whether the business can comfortably support the debt and whether the borrowed money is being used productively.
Equity
Equity represents the owners’ interest in the business.
In its simplest form:
Assets – Liabilities = Equity
If a business has $100,000 in assets and $60,000 in liabilities, it has $40,000 in equity.
Depending on the type of business and how the books are maintained, the equity section may contain several different accounts. But the basic idea remains the same: it represents the portion of the business’s net assets attributable to its owners.
How to Use Your Balance Sheet
Your Balance Sheet becomes particularly important when you borrow money.
Lenders want to know more than whether your business showed a profit last year. They also want to understand your existing debt, available cash, assets, and ability to meet your financial obligations.
Your Balance Sheet can also reveal problems that aren’t obvious on the Income Statement. For example, a business may be profitable but have very little cash because customers aren’t paying quickly enough. Another business may have strong sales but be accumulating debt faster than it can reasonably repay it.
Some assets may also be available as collateral when a business applies for financing. Even if you aren’t planning to borrow money, reviewing your Balance Sheet regularly can give you a much better understanding of the financial strength of your business.
What About Cash Basis and Accrual Basis?
Cash and accrual accounting differ primarily in when income and expenses are recognized. Under the cash method, income is generally recognized when payment is received and expenses when they are paid. Under the accrual method, income and expenses are generally recognized when they are earned or incurred, even if the cash hasn’t changed hands yet.
Many small businesses use the cash method for income tax reporting, although the accounting method appropriate for a particular business depends on the business and applicable tax rules.
Two accounts you’ll commonly encounter when working with accrual accounting are Accounts Receivable and Accounts Payable.
Accounts Receivable (A/R)
Accounts Receivable is money customers owe your business for work you’ve already completed or products you’ve already delivered.
Suppose a landscaping company completes a $5,000 project and sends the customer an invoice. Until the customer pays, that $5,000 is an Account Receivable. Under accrual accounting, that revenue is generally recognized when it is earned rather than when the cash is collected. Under the cash method, income is generally recognized when payment is received.
Regardless of the accounting method you use for tax purposes, you still need to know who owes your business money. An aging Accounts Receivable report can be particularly useful because it doesn’t just tell you how much customers owe—it tells you how long they’ve owed it.
Accounts Payable (A/P)
Accounts Payable represents amounts your business owes vendors for goods or services it has already received but hasn’t paid for yet.
For example, a contractor might purchase building materials from a supplier on account and receive an invoice due in 30 days. That unpaid bill is an Account Payable.
Under accrual accounting, the expense is generally recognized when it is incurred. Under cash accounting, expenses are generally recognized when they are paid, subject to applicable tax rules.
Even if you primarily operate on a cash basis, keeping track of upcoming bills is an important part of managing cash flow.
Don’t Ignore Your Receivables
Accounts Receivable deserves attention even if your business uses the cash method for tax purposes.
Run an outstanding invoice or A/R aging report regularly and look for customers who are taking longer than usual to pay.
Also review individual customer balances periodically. Strange balances sometimes point to bookkeeping problems—a payment that wasn’t posted correctly, a duplicate invoice, or an old balance that should have been addressed months ago.
The longer a receivable sits unpaid, the more attention it deserves.
5 Numbers Small Business Owners Should Watch
You don’t need to analyze every account on your financial statements every week. Start with a few numbers that tell you something important about the business.
1. Revenue: Are sales growing, shrinking, or staying flat? Compare the current period with the same period last year rather than looking at the number by itself.
2. Gross Profit Percentage: Are you keeping roughly the same percentage of each sales dollar after direct costs? A declining percentage can signal rising costs or a pricing problem.
3. Net Income: Are increased sales actually producing increased profit? Growth that doesn’t reach the bottom line deserves investigation.
4. Cash and Debt: Is the business building cash or relying increasingly on borrowed money? Look at these numbers together rather than separately.
5. Accounts Receivable: How much money are customers currently holding instead of you? More importantly, how old are those unpaid invoices?
Conclusion: Your Financial Statements Should Help You Make Decisions
An Income Statement and Balance Sheet aren’t just reports your accountant needs at the end of the year.
They should help you answer practical questions.
Can you afford another employee?
Do your prices still make sense?
Are expenses growing faster than sales?
Are customers paying you promptly?
Is the business carrying too much debt?
Is increased revenue actually creating increased profit?
Once you understand what the numbers are telling you, financial statements become much more useful. Instead of simply recording what already happened, they can help you decide what to do next.
Take a look at your most recent Income Statement and Balance Sheet. Compare them to the same period last year and look for the numbers that changed the most.
If you aren’t sure what those changes mean—or what you should do about them—we’d be happy to help you make sense of the numbers and use them to make better business decisions.