Do your eyes become crossed about three minutes after you try to decipher your business’ Profit and Loss Statement or Balance Sheet? As a manager it is vital to have basic knowledge of all aspects of your company, even when you have an employee or entire department that handles these financial documents. If you find reading your Profit and Loss Statements and Balance sheets mind boggling, or you have been filing them away without reading them (definitely don’t do that!), here are a few pointers to make understanding these important financial tools easier.

Profit and Loss Statements (P&Ls)

Profit performance reports prepared for a business’ managers are called Profit and Loss Statements (P&Ls), Income Statements, or Earnings statements. Regardless of the name used, these confidential reports do not circulate outside of the business and are prepared as frequently as needed (usually monthly or quarterly). They are based on a very simple formula: “sales minus costs equals profit.” Everything else in the statement is a further breakdown of the sales or cost sections into more details and subtotals but overall the statement follows the “sales minus costs equal profit” formula. All businesses include sales and costs in their P&Ls, but formats and details vary. Sales (aka revenue or income) are typically shown at the top of the P&L, why it is also referred to as “the top line.” Costs (aka expenses) are shown below sales, and profit (aka net income or net earnings) is at the bottom, which is why it is referred to as “the bottom line.”

Balance Sheet

The balance sheet (aka statement of financial position) together with the P&L and cash flow statement, make up the cornerstone of your company’s financial statements. Unlike the P&L which shows how your company performed over a period of time, a balance sheet is a snapshot of your business’ financial health at a single point in time, covering its assets, liabilities, and owners’ equity. The balance sheet shows your company’s financial position by displaying what the company owns and owes and is divided into two sides: assets and liabilities. These sides must balance each other out by using the formula “assets = liabilities + owners’ equity.” The assets and liabilities sections are each organized by how current the account is, meaning on the asset side, accounts are listed from most liquid to least liquid and on the liabilities side, accounts are listed from short to long-term borrowings. The balance sheet is so named because the two sides of the balance sheet ALWAYS add up to the same amount.

Understanding your company’s P&Ls and balance sheets are essential to being able to run your business successfully. Now go grab your P&Ls and Balance Sheets and call Buffie the Tax Heiress! Don’t avoid these reports because you think you can’t unscramble their meaning. As with any task for your business, it will become easier every time.