When you peruse your accounts, do you know what you are looking at in your profit and loss report (P&L) and in your balance sheet? This is something that is important for every entrepreneur to understand. Even if you leave dealing with the detail of the finance side of your business to others, these two reports will help you to keep tabs on your performance and to know when to put the brakes on and when to surge forward.
What they Represent
The main difference between them is that the balance sheet gives a snapshot of where you are at time the report is produced, while the P&L covers transactions over a period of time. So if you want a measure of the company’s financial health, you look at the balance sheet, while if you want to know how profitable you’ve been over the last quarter, you turn to the P&L for that period.
Why you Need them Both
Your outsourced bookkeepers will tell you that the reports need to be viewed together to get the big picture, because you could still be in trouble even if you have made good profits recently. It depends on what else has been going on.
You may, for example, have decided on an area of growth that needed a large initial investment in stock or materials. Your liabilities could exceed your assets. If you don’t make as much profit in the next period, where will the cash for the payments due come from? Keeping tabs on the big picture will stop you falling into traps like this. Most accounting systems will produce a P&L with comparable figures from the previous period, so you may be able to identify trends and potential opportunities or pitfalls.
If you are seeking finance, possible lenders will also want to examine these reports. They will think twice about lending to or investing in your business if you can’t show consistent profitability and sensible decisions in response to the figures. With an up to date balance sheet and a periodic P&L, you can see whether it’s a wise time to apply for funding. When you see that the time is right, you’ll have no problem giving potential lenders confirmation of your liquidity.
When your accounts have been brought up to date by your bookkeepers, they can produce the reports swiftly from your accounting software by entering the period or date and clicking run. It’s a good idea to schedule this activity at regular intervals and sit down together with your bookkeepers to discuss the implications of the results.