What Financial Statements Should a Business Track?

Running a business is not only about selling products or services; it is also about understanding the financial health of the company. Financial statements are essential tools that help business owners, managers, investors, and lenders evaluate how well a business is performing and whether it is financially stable. Among all financial reports, two of the most important statements every business should track are the income statement and the balance sheet.

These two statements provide different but complementary views of a business. The income statement shows how much money the business earns and spends over a period of time, while the balance sheet shows what the business owns and owes at a specific moment. Together, they help businesses make informed decisions, plan for the future, and avoid financial problems.

The Importance of Financial Statements

Financial statements are the foundation of financial management. They allow businesses to:

Measure profitability
Track expenses and income
Understand assets and debts
Evaluate financial stability
Make strategic decisions
Build trust with investors and lenders

Without proper financial statements, a business is essentially operating without a clear map. Even profitable businesses can fail if they do not manage cash, debt, and resources effectively.

Among the various financial reports available, the income statement and balance sheet are considered essential because they answer two critical questions:

Is the business making money?
Is the business financially strong?

The Income Statement

What Is an Income Statement?

An income statement, also known as a profit and loss statement (P&L), shows a business’s financial performance over a specific period of time—such as a month, quarter, or year. It summarizes how much revenue the business earned, what expenses it incurred, and whether it made a profit or loss.

In simple terms, the income statement answers the question:
Did the business make money during this period?

Key Components of an Income Statement

Revenue (Sales)
Revenue is the total amount of money earned from selling goods or services. It is usually listed at the top of the income statement.
Cost of Goods Sold (COGS)
This includes the direct costs involved in producing goods or delivering services, such as materials and direct labor.
Gross Profit
Gross profit is calculated as:
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Revenue − Cost of Goods Sold
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It shows how efficiently a business produces its products or services.
Operating Expenses
These are the day-to-day costs of running the business, such as rent, utilities, salaries, marketing, and insurance.
Operating Income
This is the profit earned from regular business operations before interest and taxes.
Net Income (Profit or Loss)
Net income is the final result after all expenses, including taxes and interest, are deducted.
- Positive net income means a profit
- Negative net income means a loss

Why the Income Statement Is Important

The income statement helps businesses:

Track profitability over time
Identify areas where costs are too high
Evaluate pricing strategies
Compare performance between periods
Demonstrate profitability to investors and lenders

For example, if a business sees revenue increasing but net income decreasing, it may indicate rising expenses that need to be controlled.

Limitations of the Income Statement

While the income statement is extremely useful, it has limitations:

It does not show cash flow (profits do not always mean cash is available)
It does not show assets or liabilities
It only covers a specific period, not long-term stability

This is why it must be used together with the balance sheet.

The Balance Sheet

What Is a Balance Sheet?

A balance sheet provides a snapshot of a business’s financial position at a specific point in time. It shows what the business owns, what it owes, and the owner’s equity.

The balance sheet is based on this fundamental equation:

Assets = Liabilities + Equity

In simple terms, the balance sheet answers the question:
What is the business worth right now?

Key Components of a Balance Sheet

Assets
Assets are everything the business owns that has value. These include:
- Cash
- Inventory
- Equipment
- Buildings
- Accounts receivable
Assets are usually divided into:
- Current assets (can be converted into cash within one year)
- Non-current assets (long-term assets like property or machinery)
Liabilities
Liabilities are the debts and obligations the business owes, such as:
- Loans
- Accounts payable
- Taxes owed
- Wages payable
Like assets, liabilities are divided into:
- Current liabilities (due within one year)
- Long-term liabilities (due after one year)
Equity
Equity represents the owner’s or shareholders’ interest in the business. It includes:
- Owner investments
- Retained earnings (profits kept in the business)

Why the Balance Sheet Is Important

The balance sheet helps businesses:

Understand financial stability
Measure liquidity (ability to pay short-term debts)
Evaluate debt levels
Determine business value
Support loan and investment applications

For example, a business may be profitable on the income statement but still face trouble if it has too much debt or not enough cash, which the balance sheet would reveal.

Limitations of the Balance Sheet

The balance sheet also has some limitations:

It shows values at a single moment in time
Asset values may not reflect current market value
It does not show profitability or performance over time

This is why the balance sheet works best when combined with the income statement.

How the Income Statement and Balance Sheet Work Together

The income statement and balance sheet are closely connected. Net income from the income statement affects equity on the balance sheet through retained earnings. At the same time, assets and liabilities influence expenses such as depreciation and interest, which appear on the income statement.

Using both statements together allows businesses to:

Understand both performance and position
Detect financial risks early
Plan growth strategies
Make smarter financial decisions

For example, a business planning to expand can use the income statement to assess profitability and the balance sheet to check whether it has enough assets or manageable debt to support growth.

Conclusion

Tracking financial statements is essential for any business, regardless of size or industry. Among all financial reports, the income statement and the balance sheet are the most important because they provide a complete picture of a business’s financial health.

The income statement shows how well a business performs over time by tracking revenue, expenses, and profit. The balance sheet shows the financial position of the business at a specific moment by listing assets, liabilities, and equity. Each statement has its strengths and limitations, but together they provide valuable insights that help businesses succeed.

By regularly reviewing and understanding these two financial statements, business owners can make informed decisions, avoid financial trouble, and build a strong foundation for long-term success.