What Is Bookkeeping? A Small Business Guide
From Tax Guide.
Tax Guide · Arab, Alabama
Profit and Loss Statement and Balance Sheet Basics
A profit and loss statement shows how a business performed over a period; a balance sheet shows what it owns and owes on one day. Here is how to read both.
The short answer
What is a profit and loss statement?
A profit and loss statement (also called a P&L or income statement) lists your income and expenses over a period of time and shows what is left.
It answers a simple question: did the business make money during this month, quarter or year? Income goes at the top, expenses come below it, and the difference is your net profit or net loss.
Because it covers a stretch of time, a P&L is like a video of your business. It shows what happened between two dates, and it is the report most owners look at first.
The second report
What is a balance sheet?
A balance sheet is a snapshot of what your business owns, what it owes and what is left for the owner on a single day.
Where the P&L is a video, the balance sheet is a photograph. It has three parts: assets (what the business owns, such as cash, equipment and money customers owe), liabilities (what it owes, such as loans and unpaid bills) and equity (the owner's share).
The three parts are tied together by a simple rule: assets equal liabilities plus equity. If your balance sheet does not balance, an entry is wrong somewhere, which is why regular bank reconciliation matters.
- Assets: cash in the bank, customer balances, inventory, vehicles, equipment.
- Liabilities: credit cards, loans, unpaid vendor bills, payroll taxes owed.
- Equity: what the owner put in, plus profit kept in the business, minus what the owner took out.
Comparing the two
What is the difference between a P&L and a balance sheet?
The P&L measures performance over a period, and the balance sheet measures financial position on a date.
You need both to see the whole picture. A business can show a healthy profit and still be short on cash, or hold plenty of cash while losing money. Each report catches what the other misses.
| Feature | Profit and loss | Balance sheet |
|---|---|---|
| Time frame | A period, such as a month or year | One specific date |
| What it shows | Income, expenses and profit | Assets, liabilities and equity |
| Main question answered | Did we make money? | What do we own and owe? |
| Also called | Income statement, P&L | Statement of financial position |
| Affected by | Sales and spending | Sales, spending, loans and owner activity |
How a sale is counted depends on your accounting method. See cash vs accrual accounting.
Putting them to use
Why do financial statements matter for a small business?
Financial statements matter because they turn a pile of transactions into information you can use to make decisions.
They show which months are strong, which costs are climbing and whether you can afford to hire, buy equipment or set money aside for taxes. Lenders often ask for them, and so do buyers, landlords and some agencies.
They also tie directly to your tax return. The income and expenses on a P&L are the starting point for schedules such as Schedule C, and our guide to business tax return types shows which return goes with which kind of business.
The method you use to keep the books changes the numbers. A business on the cash basis and one on accrual can show different profits for the same month, as explained in cash vs accrual accounting.
Reading the report
How do I read my own statements?
Read your statements the same way each month, looking first for changes and then for reasons.
On the P&L, compare this period with the last one. Which expense categories jumped? Did income slip or grow? On the balance sheet, watch cash, what customers owe you and what you owe others.
Numbers are only as good as the records under them. If a statement looks strange, the cause is often a miscategorized entry or a missing transaction, not a business problem. Understanding what bookkeeping is helps you spot the difference.
- Is income what you expected for the period?
- Are any expense categories unusually large or small?
- Do the cash and loan balances match your bank and lender statements?
- Do you owe more than you did last period?
Common mistakes
What mistakes make financial statements unreliable?
Most unreliable statements come from a few repeated habits, such as mixing personal and business spending or leaving accounts unreconciled.
A profit and loss statement is only as accurate as the categories behind it. If a loan payment is recorded as an expense, or an owner draw is treated as pay, the profit looks wrong. Unreconciled accounts can hide missing entries that change every total.
Timing errors matter too. Recording a sale in the wrong period, or forgetting a bill that arrived before month end, shifts profit from one month to another. A regular check against your bank, as described in bank reconciliation made simple, catches many of these.
- Personal spending mixed in with business expenses.
- Loan principal recorded as an expense instead of a reduction in what you owe.
- Owner draws treated as business costs.
- Unrecorded bills and unpaid invoices.
- Accounts never reconciled to the bank.
How we can help
Need help preparing or understanding your statements?
Melton Tax Services can help through our payroll and bookkeeping service.
We can keep your books in a form that produces clear reports, walk you through what they show, and use them when preparing your return.
We serve Arab and the surrounding area. Call 256-586-4635 or use the contact page. Please bring records to the office rather than sending sensitive information through the website.
Answers
Questions about p&l and balance sheet
How often should I look at my profit and loss statement?
Monthly is common for small businesses, with a fuller review each quarter and at year end. Regular reviews let you notice a problem while there is time to act on it.
Is profit the same as cash in the bank?
No. Profit is income minus expenses over a period. Cash depends on when money actually moves, and it is affected by loan payments, owner draws and equipment purchases that do not appear as ordinary expenses.
What is net income?
Net income is what remains after all expenses are subtracted from income. It is the bottom line of the profit and loss statement.
Do I need a balance sheet if I am a sole proprietor?
Many sole proprietors file taxes with only a profit and loss, but a balance sheet is still useful, particularly if you have loans, equipment or plan to borrow.
Can my tax preparer use these statements?
Yes. Clean statements make return preparation faster and more accurate, because the totals are already sorted into categories the return uses.
What is an owner draw?
An owner draw is money an owner takes out of the business for personal use. It is not a business expense and does not appear on the profit and loss statement, but it reduces the owner equity on the balance sheet.
Why does my profit not match my tax return?
Differences can come from timing, non-deductible items and the accounting method used. We can compare the two and explain the gaps.
Read next
Related reading
Cash vs Accrual Accounting: Which Method Fits?
From Tax Guide.
Bookkeeper vs Accountant: Which Do You Need?
From Tax Guide.
Payroll and Bookkeeping
A service Melton Tax Services provides.
Melton Tax Services
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