Step 1. Let's examine the financial statements of a small business. Our example business utilizes the calendar year, January 1 through December 31, as the fiscal year. The fiscal year is a determination of when the business year begins and does not have to match the calendar year. Click to begin

Step 2. We will begin the first month of reporting sales for our example business. We can report the sales with one number as "Total Sales". Click to continue..

Step 3. We can also report the sales with a breakout of the information according to cash, bankcard, and in-house charge. Some businesses utilize this method so they can better monitor the bank cards used as well as the amount of in-house charges. As we add the three amounts together, they equal the same 'Total Sales' as the first example. Click to continue..

Step 4. The next row of information is where the 'cost of goods sold' is placed. This number deals with the inventory purchased and sold in the business, but it is not the result of adding the amount of checks written for inventory during the month.

The 'cost of goods sold' is calculated by taking the amount of inventory, at cost, on hand at the beginning of the first day of the month. Added to this amount is the amount of inventory received, at cost, during the month and then subtract the amount of inventory on hand, at cost, at the close of business on the last day of the month. The resulting number is the 'cost of goods sold'.

There is not a row of information on the profit and loss statement where the amount of checks written for inventory appears. This is because inventory is not an expense. Inventory is an asset that is acquired by giving up another asset - cash. Click to continue..

Step 5. Subtracting the 'cost of goods sold', or 'cost of doing business' from the total sales the resulting number is $54,235.00 which represents the 'gross profit' for the month. We now have the necessary numbers to calculate the gross margin, also known as the gross margin percentage.

The gross margin percentage is shown to the right of the gross profit, and is calculated by dividing the gross profit by the total sales. Click to continue..

Step 6. Some businesses use the phrase 'cost of doing business' instead of 'cost of goods sold'. Most frequently, this is because the business provides a service as compared to selling a product.

To calculate the 'cost of doing business' the business uses a variation of the same formula as the 'cost of goods sold. In addition to the inventory that is a part of the sale, the labor that is necessary to complete the sale is included.

As an example, if this example business were a car repair center, the labor cost of the mechanic would be added to the cost of the parts used to repair a car. The cost of the labor for the service writer, office staff, and other employees and their related payroll expense are not a part of the 'cost of doing business.' This step does not fill in any cells in the spreadsheet. Click to continue..

Step 7. Once we have the gross profit, we now begin to look at the expenses of the business. There is not a certain proper sequence to the order in which the expenses appear on the profit and loss statement. A business could utilize a sequence of largest amount to smallest amount. The business could also group the expenses according to the definitions we are about to outline.

One of the most popular sequences is that of relationship. As an example, all expenses that relate to the building the business occupies would be grouped together. This would imply that you would show rent with electric, gas, water, sanitation, telephone, property tax, insurance and other building related expenses.

A second group would be all of the expenses related to payroll. This would include all payroll, payroll taxes, and benefits. After creating several groups of expenses, the miscellaneous individual expenses are listed last. This step does not fill in any cells in the spreadsheet. Click to continue.

Step 8. As a point of clarification, several expenses could have a unique entry on the profit and loss statement. These are situations where the business is paying a loan. Two examples are businesses that are paying a mortgage as compared to rent, and a business that is making payments on a vehicle.

With the example of a business that instead of rent of $6,750 is making a monthly mortgage payment of $6,750, the amount would not appear entirely on the profit and loss statement. Instead, the amount of interest charged by the lending institution is shown on the profit and loss statement as an expense. The rest of the payment, the principle, is reflected on the balance sheet which will be explained later. This step does not fill in any cells in the spreadsheet. Click to continue..

Step 9. All expenses can be examined in multiple ways. We mention this, because as an owner or manager reviews a profit and loss statement, these categories can help in gaining a better understanding of the operation of the business.

We can first look at expenses as fitting into one of two categories: 'controllable' or 'uncontrollable'. Uncontrollable expenses are those you cannot decide if they are going to happen. As examples, for most businesses, there is a rent or a mortgage payment. There also are expenses such as telephone, other utilities and payroll. Click to continue..

Step 10. Controllable expenses are those that the owner or manager of the business decides if they will spend the money for the expense. Click to continue..

Step 11. Another way to look at expenses would be to categorize them as fixed or variable. Fixed expenses are those whose dollar amounts do not change from month to month. Examples of this would be rent, basic telephone service, insurance - general, and computer operations. Click to continue..

Step 12. Variable expenses are those for which the dollar amount changes from month to month. Click to continue..

Step 13. As we have designated four categorizations, each expense item would have to be a combination of two of the four. As an example, rent is an uncontrollable fixed expense. However, if the business has a lease that requires the business to pay a percentage of sales as a part of the rent, then rent becomes an uncontrollable variable expense. This step does not fill in any cells in the spreadsheet. Click to continue..

Step 14. With many profit and loss statements, there is a column to the right of the dollar amounts. This column is filled with percentages and represents what percentage of the total sales that particular expense is. Click to continue..

Step 15. At the bottom of the operating expenses is a row titled, 'Total operating expenses', which gives a number which represents exactly what the name of the row implies. Click to continue..

Step 16. The total operating expenses is then subtracted from the gross profit with the resulting number being what the name of the row is titled, 'Net profit'. Click to continue..

Step 17. Sometimes, a business has other incomes and expenses that do not fit in the traditional rows of a profit and loss statement. As an example, a business may sub-rent a portion of the space they occupy. That amount of money would appear in a separate category called, 'miscellaneous income'.

With a business that has made profits and decided to invest the money, the interest from that invested money would appear in a separate category called, 'interest income'. And in some cases, a business may have an 'interest expense' that is not directly related to the business but for which the business is liable. This expense is listed in the same subsection as these other expenses and incomes we have just described. Click to continue..

Step 18. The profit and loss statement is a reflection of what has happened in the business during the month just completed. As we pass the last day of the month and these numbers are compiled, the profit and loss statement returns to all rows being filled with zero as we begin the next month.

At this point, the profit for the month just completed transfers to the balance sheet. The balance sheet is the heartbeat of the business. As compared to the profit and loss statement, the balance sheet reflects the financial stability of the business. Click to continue..

Step 19. The profit and loss statement is to be a tool that is used to make decisions. In that process, some of the most frequently asked questions by an owner or manager are, "How does this compare to last year?", "How am I doing so far this year?" and, "How does this year compare to last year?"

To answer these questions, you often see a profit and loss statement that will have 8 columns of information instead of only two. Our example sheet shows this comparison. Click to continue..

Step 20. The balance sheet has a date, just as the profit and loss statement does. The balance sheet is divided into two primary segments; the assets and the liabilities and net worth. The name 'balance sheet' reflects that the two segments have to equal each other in dollar amount. The total dollar amount of the assets must be the same as the total dollar amount of the liabilities and net worth. Click to continue.

Step 21. The assets, which are things of value that are both tangible and intangible are divided into two groups - current and long term. First, let's define tangible and intangible. Tangible means that the item can be touched; a building, cash, inventory, an investment, a vehicle, etc. Intangible is something that cannot be touched.

'Good will' or 'blue sky' represents the value that the business has built up over several years because of the continued profits and name recognition that the business has. While this is an intangible asset that would be taken into consideration when the business is sold, neither 'good will' or 'blue sky' appear on the balance sheet.

A current term asset are those that can, or are expected to be turned into cash within the next 365 days. Examples of a current term asset would be inventory and accounts receivable. Long term assets are those that will not, or are not likely to be converted to cash within the next 365 days. Examples of long term assets would be a building that you own and a vehicle. Click to continue..

Step 22. Liabilities are divided in the same manner; current and long term. Examples of current liabilities would be accounts payable, and the principle amount of any loan (vehicle, building, etc) that is payable in the next 365 days. Examples of long term liabilities would be the principle amount of any loans, (vehicle, building, etc) that are payable after the next 365 days.

These liability examples illustrate that as a business continues, a part of the principle due on any loan moves from long term liability to current term liability. With most businesses, as compared to moving an amount from long term to current term each month, they generally move an amount once each year. Click to continue..

Step 23. Perhaps the reason the balance sheet is so infrequently examined by businesses is because they believe that assets equal liabilities. And if you consider that the net worth is money that is due to the owner, that is correct. However, the proper statement on the balance sheet is that the assets equal the liabilities and the net worth. While the net worth on a balance sheet can be stated several ways, when we break it into components it is more easily understood. Click to continue..

Step 24. The owner's position in the business consists of three components. The first is the contributed capital. This is the initial, and successive amounts of money that the owner has put into the business. The contributed capital can also include a dollar valuation for other things that the owner has put into the business. As examples, the owner could contribute fixtures, equipment, inventory or a building. Click to continue..

Step 25. The second row of information is titled, 'current income'. The number in this row represents the total of the profit for the current fiscal year. Using our example business, the $7003.45 that was the net profit for the month of July on the profit and loss statement as of July 31, has moved from the profit and loss statement to now be included in the current income row. This amount joins the amount of profit that the business has earned in first six months.

The row titled, 'Current income' on the balance sheet of July 31 will then be reflective of all the profit (or loss) of the business for the current year. Click to continue..

Step 26. The next row of information is titled, 'retained earnings'. The title of this new row aptly describes what it is; earnings that have been earned by the business and have not yet been paid to the owner of the business. Click to continue..

Step 27. When the business has completed the 12 months of the fiscal year, the term 'current' has expired. The total of the 'current income' has to move to the row below it that is titled 'retailed earnings'. The amount of the 'current income' for this year is then added to the amount that is already in the 'retained earnings' row.

As the 12th month of the fiscal year is completed, there will still be an amount for the row of 'contributed capital' and 'retained earnings' but the row for 'current income' will remain at zero until the first month of the new year has been completed. Click to continue..

Step 28. When you add together, the 'contributed capital', 'current income' and 'retained earnings', the resulting number appears in the next row that is titled, ' Stockholder's equity'. This amount represents the total financial position of the owner of the business. Click to continue..

Step 29. This is how the profit and loss statement and the balance sheet can be completed by a business each month. Creating these documents, understanding them, and making decisions based upon their information, lead to a business owner that is in control of their business. This step does not fill in any cells in the spreadsheet.