The statements you’re making your entries into are called balance sheet and income statement. These are the ones that are the most important and the mostly used – for government officials, investors etc. Importance of those two statements is something we’ll cover in more detail further below, but let it be said that there are two or even three other statements one can present for a company – statement of cash flows, statement of comprehensive income and statement of changes in owner’s equity. Those are the statements that mostly just form from the main two and are not separate statements you make entries into. These statements come into play when you’re preparing your company’s annual report and you’ve got to present all sorts of detailed information about your company’s results and performance. However let us move now to those two main statements.

Balance Sheet
A show of your assets and liabilities, it’s what the balance sheet is all about. As the name says, it’s a balance and as such it’s where something balances with something else, i.e. your assets must always equal the sum of your liabilities and equity. You can look the balance sheet as two columns – assets are what your company owns and liabilities alongside with equity are something others (other than the company itself) have invested into your company. How does it always equal? Well, as you recall, all accounting entries have at least two lines – one debit and one credit and since they are always equal, the balance sheet will always have equal sides. It must balance. On one side you acquire something, but with acquiring until you haven’t given up your other assets, you owe something, which means someone else “invested” money into your business. Until you haven’t paid up this debt, they are your investors (or creditors). But enough about arithmetic and philosophy, let’s continue with the balance sheet itself.

On your company’s balance sheet what you do is group similar assets into one category – i.e. current and non-current assets. The similar grouping should be done with liabilities – current and non-current liabilities. What’s similar about those? Current means it’s either to be made liquid, meaning you get cash in return (for assets) within next 12 months from the balance sheet date or to be settled (for liabilities) within next 12 months from the balance sheet date. And consequently everything else is non-current meaning they are to be settled (made liquid or paid up) within more than 12 months from the balance sheet date. Yes, as you may have gotten the 12-month period is the key here. What it means literally is within next financial year and hence the split of assets and liabilities. Investors and everyone else reading your reports are interested to know of your liabilities you’ve got to pay up during the next financial year and what have you got in return to settle those debt balances, i.e. your current assets you should be able to collect as cash and obviously cash balances themselves. That’s what the current and non-current balances are all about.

Obviously, a more detailed balance sheet would include different account numbers and accounts on their own, but if you’re presenting your balance sheet to someone, it’s wise to group similar type of assets into subgroups, like prepaid expenses for an example. You may have separate accounts for prepaid rent, fees, subscriptions etc., but on the not-so-detailed balance sheet they’re all “prepaid expenses” for an example. And it’s the same with liabilities, nothing different here when it comes to showing those balances.

What a balance sheet in short is, it is a summary of what your company owns on its own and what it owes for what it owns or will own or did own (as liabilities are something that a company can still have even after they’ve already disposed of the asset they acquired). Note here that the balance sheet is always for a specific date – balance sheet date. This date represents the date when the reporting period ended. It’s the date, when reported together, your income statement should have its period’s ending date. For an example, if your balance sheet date is 30.06.2012 and you’re reporting for the period of 31.12.2011 until 30.06.2012, your income statement is prepared for the period of 31.12.2011 until 30.06.2012.

Income Statement
The income statement is something that shows your incomes (as the name says) and your expenses just as well. The reason it’s called “income” statement is because it starts off with your revenues and by taking off all your expenses you made to get to those sales, we’re left with net profit, which is your income. Income in the sense that it’s what you can say you earned.

Another reason it’s called income statement inevitably comes from the purpose of a company – making profits, i.e. earning income. It’s to show if and if so how much your company earned during the reporting period the statement is prepared for. Something that’s different when it comes to income statement compared to the balance sheet is the fact that this statement is prepared for a period and not for a specific date. An income statement is for a certain period – a month, a quarter or a year – whatever is required and you choose to report. When you present your income statement, do make it a point to present it with a heading that’s for a period and not just the ending date of the said period. It’s such a common mistake to make and yet so easily avoidable.

Something to also note about the income statement is grouping. Similar types of revenue are always grouped together and so are expenses. You wouldn’t want to show your renting expenses under car fuel expense accounts, would you? Well, you shouldn’t. So what you should do is just show similar transactions grouped under lines which describe the expense the best, i.e. if your company rents cars, buys fuel for them, pays for the insurance and maintenance, why not group them under something called “car expenses” for an example?

And it’s not all. When it comes to showing your income statement to those that are interested, you would want to group it more – group expenses based on their function or nature.

It’s something we’re explaining in more detail in our course, but very shortly I’ll fill you in. When we talk about grouping expenses based on their function it’s meant so that you group expenses which are made for similar business division, i.e. marketing, production, administration etc. All personnel expenses, depreciation, office expenses made etc. are grouped under which division they are made within. If for an example you have marketing activity, you’ve got people responsible for it, all of their expenses are shown under marketing expenses on the income statement – payroll, car rent, car fuel, room renting, utilities etc.

Now, when we talk about grouping expenses by their nature though, it’s like the name says, by their very nature – personnel costs (payroll, social tax etc.), depreciation, operating expenses etc. You paid salaries, it’s personnel costs and by nature it’s grouped under there.

And that’s very shortly what the income statement is about. It’s to show all your revenues and all the expenses your company along with all your employees made for those revenues. And obviously what’s left of your revenues after those expenses, i.e. your net profit. Something making a business is all about.