| As you consider which legal entity or | | | | Assets=Liabilities + Equity It's really quite logical how |
| entities--corporation, limited liability company, or limited | | | | the Income Statement and Balance Sheet relate to |
| partnership--you want to use for your business | | | | one another. If you have to use current or long-term |
| structure, the decisions you make will depend heavily | | | | assets to pay ongoing expenses during the current |
| on your current financial situation, both personal and | | | | year, at the end of the year, the amount of your |
| professional. But do you know how to read a financial | | | | assets will be reduced by the amount of net loss. On |
| statement on your own? Do you know how to read | | | | the right hand side, your Equity has gone down too. |
| your own personal and business financial statements? | | | | If you borrowed, say $10,000 to pay current |
| Knowing how to do this is an essential skill not just | | | | operating expenses, at year end, your assets remain |
| for entrepreneurs but for everyone. However, for | | | | the same, but your liabilities have increased by |
| the entrepreneur having this skill can mean the | | | | $10,000, lowering your net Equity or ownership in the |
| difference between having a thriving business that | | | | company by that same $10,000. It doesn't take a |
| continues to thrive and winding up in bankruptcy. The | | | | rocket scientist to figure out that if you continue on |
| annals of the bankruptcy courts are strewn with | | | | this path, you will quickly be in a very painful situation, |
| cases of entrepreneurs who entrusted their | | | | because Liabilities carry their own cost. The cost of |
| accounting to others and, not knowing how to read | | | | borrowing money is Interest, and if you are |
| the financial statements of their own businesses, | | | | fortunate enough to borrow at only 10% interest (on |
| were surprised when they found that the business | | | | unsecured debt) today, a year from now, you will |
| was ultimately unsustainable. The purpose of this | | | | have to pay $11,000 to pay off the original $10,000 |
| article is to help prevent this from happening to | | | | debt. This reduces your equity still further--unless you |
| you--and to arm you with the skills you need to | | | | have used the borrowed funds to create more |
| structure your business to your benefit from the | | | | assets that increase in value at the same rate as the |
| outset. Your Two Major Financial Statements There | | | | interest on your debt or, better yet--at a higher rate. |
| are two major financial statements that every | | | | More to the point for deciding which business entities |
| entrepreneur should know how to read and (ideally) | | | | to use is that you need to work out both your |
| prepare or have prepared in their financial software | | | | personal financial statements and those of your |
| (we recommend QuickBooks): The Income | | | | business(es). If you find, for example, that that you |
| Statement The Income Statement (also known as | | | | have significant salary or wage income in your |
| the P&L or Profit and Loss Statement) offers a | | | | personal financial statements that is causing you to |
| dynamic picture of the ebb and flow of your | | | | pay out high taxes (as reflected in your balance |
| finances. Briefly, income statement shows first: A. | | | | sheet), and you expect that your business will |
| Your various sources of income Then subtracts from | | | | generate some significant losses for the first several |
| that, B. Your expenses To give you the net result: | | | | years, it would be advantageous to you to use a |
| Net Profit or Loss Typically, it is the result shown on | | | | business entity that is a flow-through entity. Losses |
| this statement that is the basis for your taxation by | | | | incurred by your S-Corporation (or, if you prefer, |
| state and federal authorities at the end of the year. | | | | your Limited Partnership or your Limited Liability |
| The net income or loss (revenue outgo) is carried | | | | Company) will flow onto your personal balance sheet |
| over onto your second major financial statement: | | | | to offset the salary or wage income and thus reduce |
| The Balance Sheet. The Balance Sheet Offers you a | | | | your tax liability. Moreover, in general, if you want to |
| snapshot of cumulative results of your financial | | | | draw up a roadmap to getting where you want to |
| activities. It is made up of two columns: On the left | | | | go, you need to know your point of departure. Thus, |
| side you have your Assets On the right are listed | | | | preparing and understanding your personal and |
| your Liabilities and Owners/Shareholders Equity (or | | | | business financial statements is an indispensable first |
| ownership in the business). The two columns must be | | | | step for your business planning. |
| in balance, which is why this is called a Balance Sheet. | | | | More articles from this pro: A. Hoston, Ph.D. |