Continuing our series Understanding Financial Statements Part 1 today we look at the Balance Sheet and the Profit And Loss Statement. Both are important as they help you understand the financial health of your business.

To learn more visit the D&B website where you can read the entire "Understanding Financial Statements" series.

Balance Sheet And Profit And Loss Statement

There are two parts to the financial statement - the balance sheet and the income (profit and loss) statement.

A balance sheet is a detailed snapshot of the condition or financial health of a company on a specific date. December 31st is the most popular choice among business, however many seasonal businesses issue their statements after their main selling season, because their condition is most favorable at that time. Balance sheets show the dollar amount of assets (what the business owns) and liabilities (what a business owes) in relation to net worth or owner's equity (what the owner, principals or stockholders own). Balance sheets are presented with assets on the left side of a page and liabilities and equity on the right. Totals of both left and right sides must balance, since total assets must equal total liabilities plus net worth.

The income or profit and loss statement is a detailed computation of the money a business makes or loses over a specific time period. Sales or service income is offset against expenses-operating and production costs. You will most often see year-end statements reflecting income and expenses for a particular calendar year.

Comparing Trends From Year To Year

A shortcoming of reviewing a single financial statement of a business is the inability to establish important trends. However, when you compare two or more successive financial statements of the same concern, a trend becomes apparent. Individual items of the balance sheet and profit and loss statement compared with identical items on previous statements can be significantly reveling in decision making. This observation process is called comparative analysis, which we'll use throughout this guide. Keep in mind, comparative analysis of a company's financial statement to its previous results and to industry averages is essential in assessing its financial health.

Balance Sheet Components

As mentioned earlier, the balance sheet is the financial statement that reports the assets, liabilities and net worth of a company at a specific point in time. Assets represent the total resources of a company, which may shrink or increase depending on the results of operations. Assets are listed in liquidity order - ease of converting into cash. Typical assets include: cash, accounts receivable, inventory, fixed assets and a number of miscellaneous assets we have classified as other. Liabilities include what a company owes: accounts and notes payable, bank loans, deferred credits and miscellaneous other. All businesses divide assets and liabilities into two groups: current (convertible to cash within a year) and noncurrent. Net worth is the owner's investment (in the case of a proprietorship or partnership) or capital stock (original investment) plus earned surplus (earnings retained in the business) in the case of a corporation.

Understanding Financial Statements Part 1