At some point, you may need to buy equipment, tools, and other assets for your business. Those assets tend to wear out after several years and lose their value. Luckily, businesses can write off those expenses if they know about depreciation and how to calculate it. 

The straight-line depreciation formula is the simplest and most common way to calculate depreciation. In this article, we’ll go over the basics of depreciation and show you how to calculate it with the straight-line depreciation formula. 

What Is Depreciation?

Depreciation is the decrease of an asset’s value over time. You need to know about depreciation for tax purposes and to make sure financial statements are accurate. Business owners and accountants can use it to write off the costs of certain assets. 

Depreciation is typically calculated using one of several methods. Most commonly, you’ll use the straight-line method or the declining balance method. 

Tax considerations, accounting principles, or other factors will determine which method you should use. 

What Is Straight-Line Depreciation?

Straight-line depreciation is more simple than the declining balance method.

The straight-line depreciation method spreads the cost evenly over the life of an asset. Each year, you expense the same percentage. 

For example, let’s say a company purchases a $1,000 machine. The machine has a five-year useful life. The useful life represents how many years an asset will last. It’s also an estimate. Under the straight-line method, the machine would depreciate by $200 per year. 

Then, you would report the depreciation expense on your company’s annual income statement for five years. 

Straight-Line Depreciation Formula – How To Calculate It

To calculate an asset’s value, you need to know the straight-line depreciation formula and how to apply it. The straight-line depreciation formula is: 

• Depreciation expense = (Asset cost – Residual value) / Useful life 

Asset cost stands for the price at the time of purchase. For example, a golf course buys a cart for $12,000. The asset cost is $12,000. 

The residual value is the asset’s estimated value by the time it reaches the end of its useful life. It is also sometimes called salvage value. 

The straight-line depreciation formula can be used for any type of asset. However, it is most commonly used for depreciating business assets. This can include: 

• Buildings
• Machinery
• Equipment
• Vehicles
• Furniture

You can use the formula to calculate your straight-line depreciation expense. It’s the amount that can be written off each year. 

Straight-Line Depreciation Example

Consider an equipment purchase for $15,000. It has a useful life of five years. You estimate that at the end of five years, the equipment will have no value. The depreciation each year would be $3,000 (($15,000 – $0) / 5). A depreciation chart would look like: 

Other Depreciation Methods

There are three main types of depreciation: straight-line, declining balance, and sum-of-the-years’ digits. We know that straight-line depreciation spreads the cost evenly over the life of the asset. 

Although the straight-line method makes it easier to calculate depreciation, it does not reflect the true value or usage of an asset over time. For example, after you purchase a vehicle, you typically use it the most during the first few years. However, it can still have value several years after.

Let’s look at other methods. 

Declining balance method

Declining balance depreciation considers that an asset will be used more often in the first few years, so it will lose value then. 

You can calculate the declining balance method by multiplying a fixed depreciation rate by the current book value (CBV). The CBV is the asset’s estimated value in that accounting period. 

If we look at the same example as above: 

Note that the declining balance method produces larger expenses in earlier years and smaller expenses in later years. There is also the double-declining balance method which uses twice the rate of depreciation (i.e. 40% in the example above).

You may use the declining balance method to depreciate assets that lose value and become obsolete quickly. For example, you might use it to calculate depreciation for computers since they have a shorter useful life. 

Sum-of-the-years

The sum-of-the-years’ digits method is more complex. It provides a more accelerated schedule of depreciation than straight-line or declining balance methods. 

You calculate the yearly deduction by multiplying a fraction (the sum of all digits used to represent time periods divided by time period) by the asset cost. Then, you minus any salvage value. 

In our earlier example, you would calculate Year 1’s deduction by taking 5 divided by 5+4+3+2+1 multiplied by $15,000. You’d calculate Year 2’s deduction by taking 4 divided by (5+4+3+2) 5+4+3+2+1. Then, you multiply by $15,000. As you can see, this approach gets confusing. In most cases, you won’t need to use the sum-of-the-years.

When Do You Use the Straight-Line Method?

You should use the straight-line formula to depreciate an asset that steadily loses value each year. Assets like real estate and large equipment often use straight-line depreciation. 

It’s simple to calculate. However, the downside is that it does not reflect the true cost of certain assets.

When you know what depreciation is and how to calculate it, you can recoup some costs for purchasing assets. Depreciation can also reduce the amount of taxes owed. Luckily, you don’t need to do all the bookkeeping and accounting to calculate depreciation. With xendoo, you can get an experienced bookkeeper, accountant, tax professional, and CFO all in one place. View our plans to decide which option is right for your business. 

The process of 3-way matching in accounts payable protects your business against incorrect or fraudulent invoices. It mitigates risks in your company’s spending by making sure you don’t overpay for services or fall for counterfeit invoices.

It may sound like no one would fall for invoice fraud—when a scammer pretends to be a business partner or vendor and sends a company an invoice for services that they didn’t actually deliver. Usually, it is sent through a business email that might appear legitimate and requests that the recipient send payment through a wire transfer.

However, invoice fraud happens more often than you’d think and to some huge companies. A few years ago, Google and Facebook both fell for a fake invoice and paid over $123 million to a Lithuanian scammer. Now, tech giants can afford to go after the scammers in an attempt to recover their funds, which Google and Facebook did. But, most small businesses can’t do that and can face devastating losses when they lose funds to tricks like these. 

One way that you can protect your business from fraudulent or incorrect invoices is by 3-way matching in accounts payable. In this guide, you’ll find everything you need to know about 3-way matching and how to use it. 

What is 3-Way Matching?

Three-way matching is the process of verifying an invoice is legitimate and the amount is accurate by looking at three documents. 

• Purchase order (PO)
• Receiving report
• Supplier’s invoice

We’ll go into each of these in detail later, but all three documents are needed to do a 3-way match. 

A 3-way match verifies invoices by comparing documents to prove your business:

• Requested products or services in the invoice and it is legitimate
• Received the types and quantities of goods that the supplier agreed to in the invoice 

You implement 3-way matching in accounts payable before issuing payment. Although 3-way matching primarily focuses on eliminating fraudulent invoices, it can also save you money by revealing an unintentional human error in a supplier’s invoice. 

It can tell you the correct amount and type of products you ordered from a supplier and ensure you only pay for what you received. 

Three-way matching is also part of the procurement process—getting, or procuring, goods and services for your business.

What is the Difference Between 2-Way, 3-Way, and 4-Way Matching?

While 3-way matching is the most popular method, it’s not the only way to compare invoices with other related documents. Other methods include 2-way and 4-way matching. Let’s identify how they differ.

2-Way Matching

If you use 2-way matching, you’re only comparing two documents—the purchase order and the supplier’s invoice. This method may be less time-intensive than 3-way and 4-way matching, but it leaves room for costly errors. 

Suppose your business needs 150 products and sends a purchase order to supplier X for the required quantity. However, the supplier mistakenly delivers 145 products and sends an invoice to your business for 150 products. 

Since 2-way matching only compares your purchase order and the supplier’s invoice, you will overpay the supplier for 150 products when you received 145.

Because 3-way matching uses a receiving report, you only pay for what you agreed to. In the above example, you’d only pay for what you received—145 products.

4-Way Matching

The process of 4-way matching in accounts payable compares four documents.

• Purchase order
• Supplier’s invoice
• Receiving report
• Inspection information

The inspection information is a report that the company uses to determine whether or not to pay for goods after an inspection. It may have a particular product quantity—above or below what it ordered from a supplier—that it can accept.

Many companies don’t need 4-way matching because the fourth verification step (inspection report) is nearly always unnecessary to establish an invoice’s legitimacy and accuracy. However, some enterprises may choose a 4-way match to manage frequent and large purchases. 

How Does 3-Way Matching Work? 

The 3-way match system tells you if the supplier invoices you’re paying are accurate — either accidentally or on purpose. How does it work? 

First, you need the three documents mentioned above. Then follow the steps below to verify invoices before issuing payment. 

1. Purchase Order

You’ll first look at the purchase order for verification. As a best practice, your business should not buy anything without a purchase order prepared in advance and entered into your accounting records. 

Once counter-signed by the supplier, the purchase order is a legally binding document. It should specify:

• Names and quantities of items to be bought
• Price of items
• Delivery date

2. Receiving Report

Once you have a purchase order, you’ll create a receiving report. To create this, you’ll check all the supplies you received and add them to your inventory. Look at the quantity and types of items to make sure it matches the purchase order. 

The report should then be entered into your accounting software. If you have an accountant or accounts payable staff, they can do this for you. 

A typical receiving report includes:

• Date and time of delivery
• Purchase order number
• Name of vendor and/or shipping company
• Description of each item received
• Quantity of each item received
• Condition of items received (necessary for returning damaged goods)

3. Supplier Invoice

The bill sent by the vendor should match both the purchase order and receiving a report in item names, quantities, and prices. It is the responsibility of accounts payable to make sure these three documents match — and if they don’t, find out why not.

Discrepancies may be resolved by having the supplier issue a revised invoice, or in some cases a credit memo. 

PO vs. Non-PO Invoices

When implementing 3-way matching in accounts payable, you should only use (PO) invoices. Non-PO invoices are unsuitable for a few reasons. 

PO invoices have a purchase order attached to them. They have all the details in a purchase order as well as an order number. 

On the other hand, a non-PO invoice is when a company buys something without a purchase order. It is also called an expense invoice because it usually refers to expenses incurred. Examples of non-PO invoices are: 

• Employee travel or meal reimbursement
• Mileage reimbursement

Example of 3-Way Matching

To illustrate how a 3-way match works, here’s an example. 

Caffeinated, a coffee shop chain, wants to order 500 products priced at $6 each from supplier Y. The coffee shop sends a purchasing order (PO) to supplier Y. In this case, the total product cost will be $3,000. 

Once the supplier delivers the order, Caffeinated’s receiving staff checks and records the inventory to verify whether the delivery matches the purchasing order. 

One week after delivering the orders to Caffeinated, supplier Y sends an invoice for the delivered products. 

The accounts payable team cross-references three documents—purchasing order, the receiving report, and the supplier’s invoice. The team compares product quantity, cost per unit, and total costs in the three documents. 

Should there be any discrepancies, the 3-way matching process will find them. For instance, if the supplier’s invoice mistakenly indicated that 550 were delivered, yet only 500 were, Caffeinated wouldn’t pay for the mistake. The receiving report will show the right product quantity and that is what you’ll pay. 

Benefits and Drawbacks of 3-Way Matching 

The benefits of 3-way matching are obvious: the prevention of human error or fraud which could result in financial losses for your business.

On the drawback side, the process can be time-consuming for accounts payable. 

This could lead to delays in payment, resulting in late fees and disqualification for early payment discounts. Consider these accounting tips to make it more efficient:

• Use software that automates purchase orders and receiving reports, and integrates them with your accounts payable
• Don’t require a 3-way match for recurring or small-dollar invoices
• Allow accounts payable staff to approve invoices if the amounts on the purchase order and the invoice are within a few percentage points of matching

Some of these solutions may be beyond the budget of most small businesses, but not when you use xendoo. 

Our accounting software gives you enterprise-level capabilities at an affordable monthly fee. It’s just one of the ways we relieve ecommerce and small business owners from the work and worries of bookkeeping and free their minds to focus on doing what they love. Get a free trial today or talk with a xendoo accountant. 

If you’re managing a business—and your books—you’ve probably had to learn what is accounts payable vs. accounts receivable. 

Accounts payable and accounts receivable are two different sides of the same coin. In this case, the coin is your business. One tracks money that is going out. The other tracks money coming in. Both are important to maintain a steady cash flow and grow your business.

Without a deep understanding of your accounts payable and receivable, you could face costly setbacks.

At xendoo, we’ve prepared a detailed guide about accounts payable vs. accounts receivable to help business owners stay on top of their cash flow. Let’s dive deeper to learn more. 

• What Is Accounts Payable?
• What Is Accounts Receivable?
• Accounts Payable vs. Accounts Receivable
• How to Record Accounts Payable
• How to Record Accounts Receivable
• Accounts Receivable Turnover Ratio

What Is Accounts Payable? 

Accounts payable (AP) is what your business owes creditors—like the amounts for products and services you bought on credit. Accounts payable is a liability account entailing debts (both long- and short-term) due in a specified period, usually a year. 

Accounts payables are balance sheet entries. You record them under ‘current liabilities on the balance sheet. 

If you don’t handle it accurately and efficiently, you won’t pay what your company owes on time or overspend. That means jeopardizing supplier relationships and incurring late payment penalties, among other consequences.  

Accounts Payable Examples

The actual entries you record in your general ledger differ from business to business. However, typical categories of accounts payable include: 

• Rent and lease payments
• Travel expenses 
• Business equipment and supplies
• Raw materials to make products
• Transportation and logistics

To record accounts payable, here are a few examples.

Example 1

Suppose your beer company orders $1,000 barley from supplier X. Supplier X sends an invoice on the 15th of June with a 30-day payment period. The $1,000 is accounts payable, and you record it in your general ledger by crediting $1,000 on the supplier’s X account. Then, debit $1,000 into your asset account. 

Example 2

Let’s say your business receives a $500 monthly electric bill. In that case, $500 is accounts payable that you credit on your business journal and debit on your utility expense account. 

What Is Accounts Receivable? 

Accounts receivable (AR) is the money customers owe your business for the goods or services you sell to them on credit. Accounts receivable is an asset account on the general ledger and balance sheet. You record the account receivables in the balance sheet under ‘current assets.’ 

To account for accounts receivable, you need to invoice, collect, and record customer debts.

Understanding your accounts receivable can help you evaluate your overall financial liquidity and stability. 

If you don’t manage receivables well, it may translate to a negative cash flow. For a healthy accounts receivable, you should have an accounting system that accounts for and limits bad debts. 

Accounts Receivable Examples

Typically, accounts receivable include the sale of goods or the supply of a service that hasn’t been paid in full yet. However, the amount is expected to be paid in the short term, within a year or less. 

Example 1

Assume you are an electric company that charges clients after using electricity. In this case, the unpaid invoices (bills by clients) represent the accounts receivable in your company. You record them as current assets in your general ledger and balance sheet. 

Example 2

Suppose your business supplies $1,000 barley to a beer company on credit. In that case, you will record $1,000 as an asset in accounts receivable.

If you’re curious about how other businesses record their accounts payable and receivable, you can easily view the quarterly and annual reports of public companies. Companies submit reports to the U.S. Securities and Exchange Commission (SEC), as well as directly through the company site. 

For example, you can see Nike’s balance sheet listed accounts receivable under assets and accounts payable under liabilities. (Figures are in millions). 

Accounts Payable vs. Accounts Receivable

While accounts payable and receivable are different, they have some commonalities. 

• Both accounts payable and receivable are general ledger entries—one as a liability and the other as an asset. 
• You need an overview of both to get an accurate picture of your business’s financial health. 

Analyzing accounts receivable can give you a picture of your total payment owed, and the success rate of your debt collection efforts. 

On the other hand, accounts payable tells you if you are able to pay business debts. Combined, they show your company’s financial stability. 

Accounts payable and receivable are equally important. It’s critical to use the right tools to track, record, and manage both. 

Differences Between Accounts Payable vs. Accounts Receivable

Accounts receivable are assets while accounts payable are liabilities. Accounts receivable amounts must be accurate to help you establish business profitability. 

Second, you can sell your accounts receivables to a lender when you need cash urgently and can’t wait for customers to pay their debts. This method is called invoice financing or accounts receivable financing. 

While a finance company (e.g., a bank) might refuse to buy your invoices past due dates, a debt collection company may buy them at a discount. It is not ideal, but it can add more value than writing off the bad debt. 

On the other hand, accounts payable are liabilities because your business will pay the debt within a specific timeline. 

The table below summarizes the differences between accounts payables and accounts receivable. 

Your accounts receivable and account payable should be efficient. That way, you will avoid issues during auditing and prevent getting caught up in fraud by unethical suppliers.

When managing your accounts payable, ensure all entries are accurate by minimizing accounting errors in your business. On top of that, watch out for suppliers who may mistakenly bill for more products than they have delivered. 

When managing your accounts receivable, ensure that debtors pay what they owe on time. If the accounts receivable are way past their due dates, you may need to adjust your expectations. 

Debts past due dates (with several months) might translate to bad debts, which you should remove from accounts receivable and record as an expense. 

How to Record Accounts Payable in Accounting

When recording accounts payable, you either use the cash or accrual accounting method. 

Cash vs. Accrual Accounting

Cash-basis accounting is simpler than accrual accounting. With cash basis accounting, you record transactions on a cash basis as they happen—after the money exchanges hands. 

That means you record expenses after the business pays the bills or debts from creditors. For example, let’s say you bought supplies on credit on June 1st and payment is due June 30th. You don’t record the transaction in your books on the 1st but the 30th, when you make the payment.

On the other hand, accrual accounting refers to recording transactions as they happen, regardless of whether or not money exchanges hands. In the above example, you would record the transaction in your books on June 1st instead of waiting for the 30th. 

Which accounting method should you use? 

Consider cash-basis accounting if you own a small business or make products on demand. On the other hand, accrual accounting suits you best if you have a business with a large inventory. Read our full cash basis vs. accrual accounting guide to help you choose the method for your business. 

How to Record Accounts Receivable in Accounting

Recording accounts receivable is a little more involved because you have to coordinate customer invoices and payments. To help your business get paid on time, here are some accounts receivable tips: 

1. Run a credit check

Unpaid invoices happen, but you can limit and prevent some by taking measures like running a credit check before delivering goods or services. Other tips for preventing late and unpaid invoices include: 

• Get a signed agreement on payment terms before starting work
• Get a personal guarantee which gives you the right to sue the business owner personally—rather than the business—for unpaid debts. (Save this one for those with a bad credit record.)
• Send your invoice immediately after work is done
• Track the customer’s payment history with you and deal with those who are consistently late payers. (Change payment terms or stop doing business with them.)
• Make it easy for customers to pay you with options such as debit card, credit card, PayPal, Stripe, and more.

2. Send an invoice

As mentioned above, invoices should be sent in a timely manner. The easiest way to do this is with online invoicing software. The invoice is sent to the customer by email and the amount owed is automatically entered into your bookkeeping and collections system.

Good software should also allow ways for the customer to make payments online with a credit card or bank transfer. All xendoo plans come with invoicing software Xero, and include templates and more. 

With invoicing software, your accounts receivable staff and your customers can save a lot of time. 

2. Track payments

You’ll also want to track payments and set up automatic reminders to go out when payment is near due, and if it’s late. 

Your accounting software should be able to generate an aging report, which lists past-due invoices in order from the least to the most number of days since the due date. Do this regularly, because the longer you wait to pursue payment, the less likely it is that you will ever get paid.

3. Set a timeline for collections

Next, you need a strategy in place for aging (overdue) invoices. Your accounting software should be able to automatically send past-due reminders, according to trigger dates you’ve established. To plan your collections, answer the following:

• How will you notify the customer when a payment is past due? Will you send a second notice invoice through email, snail mail, or phone call?
• How many reminders will you send before you escalate overdue payments? 
• Will you cut off sales until the outstanding balance is paid?
• When will you take actions like charging late fees or sending overdue invoices to a debt collector? 

Your software should also be able to generate an aging report, which shows you at a glance all your past-due invoices listed in order from least to most overdue. 

4. Record bad debts

If all your efforts to get the invoice paid have failed, the time has come to write it off as a bad debt. 

You decide when that write-off will occur. Typically, if an invoice hasn’t been paid in 6 months, it is not going to be paid.  

Be sure to include the write-off on your income tax return. If the customer does eventually pay, you can declare it as income on next year’s tax return. You’ll also need to get a tax refund if you’ve already paid taxes on the expected income. 

Failure to collect debts is one of the top reasons small businesses go out of business. So it’s super important to make consistent, persistent efforts to get the money owed to you. 

Accounts Receivable Turnover Ratio

How do you know if your accounts receivable process is working? The accounts receivable turnover ratio measures how efficient your business is at collecting payments. 

It shows how you manage customer debts by showing how quickly you collect them. A higher receivable turnover ratio shows that your business manages debts efficiently. 

A lower ratio translates to inefficient debt management. Here’s the formula for calculating your accounts receivable turnover ratio. 

• Accounts Receivable Turnover Ratio = Net Credit Sales ÷ Average Receivable

Net credit sales represent debts you collect later. Below is the formula for net credit sales. 

• Net Credit Sales = Credit Sales − Sales Returns − Sales Allowances (Discounts)

The average receivable is the starting and ending receivables over a set period of time divided by two. 

• Average Receivable = (Starting AR + Ending AR) ÷2

Example of the Turnover Ratio

A vintage shop had gross credit sales of $50,000 and returns of $5,000. The starting and ending accounts receivables for that year were $5,000 and $7,500. Here’s how to find the account receivable turnover over ratio for that year. 

• Receivable Turnover Ratio = (50,000 − 5,000) ÷ [(5,000 + 7500)÷2] = 7.2

The business collected accounts receivable approximately 7.2 times over the year. 

Mismanaged accounts payable and receivable can tank your business. If you don’t have the time, capability, or desire, xendoo can help. Our plans come with advanced bookkeeping software, an automated accounts receivable process, expert debt management, and income tax guidance. Request your free trial today to get started or chat with a xendoo expert bookkeeper.  

Balance sheets and income statements are indispensable financial tools for all business owners. What should businesses know about the balance sheet vs. income statement?

The two complement each other in tracking vital financial metrics such as net income, expenses, profitability, and more. However, there are differences between the two documents.

Understanding these statements can be the first step in making better financial decisions and improving your business performance. 

This guide provides an extensive overview of the balance sheet vs. income statement to help you understand what they mean for your business.

What is a Balance Sheet vs. Income Statement?

Financial statements like balance sheets and income statements give you insights into your business’s financial performance and health. 

Usually, a balance sheet represents what a business owns and owes at a specified time. An income statement explains a company’s total revenue and expenses.

Accountants prepare the two statements from financial records. Businesses use them to determine how well they are doing, their worth, and the areas that require improvement. 

When combined, the balance sheet and income statement provide a better knowledge of the overall financial position. 

What is a Balance Sheet?

A balance sheet provides a clear view of its financial position at a specific time. Its key components are assets, liabilities, and shareholder’s equity. Assets represent what a business owns, including cash, property, trademarks, and equipment.

Liabilities include everything the company owes, such as short-term and long-term debts. Stakeholder’s equity represents the remaining assets after settling all liabilities. Overall assets are equal to the summation of the total liabilities and shareholder’s equity. Like any other financial statement, the structure of a balance sheet will vary based on the company.

• Assets = Liabilities + Shareholder’s equity 

Usually, businesses create balance sheets every fiscal quarter and at the end of the fiscal reporting year. You can track company performance since inception, including all transactions, acquired assets (and their current valuations), and accumulated debts, all in one statement. Let us look at the components of a balance sheet in detail.

Assets

Assets in a balance sheet represent what your business owns at a specified time. There are two classifications of assets, namely current and long-term or non-current assets. The current ones are those that are effortlessly convertible into cash. Types of assets include: 

• Cash and cash equivalents (Stocks and bonds)
• Inventories
• Money in the bank
• Accounts receivable
• Short-term investments
• Prepaid expenses

Conversely, it is not easy to convert non-current assets into cash. In other words, non-current assets are assets that you do not expect to generate revenue within the accounting year. 

Non-current asset examples are:

• Properties such as land and buildings
• Intangible assets like patents, copyrights, and trademarks
• Machinery and equipment
• Long-term investment

Liabilities

A company’s liabilities are what it owes to creditors and vendors. Just like assets, there are two categories of liabilities—current and long-term. The current ones are those that are due within one accounting year. 

Current liabilities may include:

• Accounts payable
• Accrued expenses
• Employee wages
• Taxes

Long-term liabilities are a company’s financial obligations that are due more than one accounting year in the future. 

Long-term liability examples include:

• Mortgages 
• Loans
• Payable bonds
• Dividends payable

Stakeholder’s Equity

Stakeholder’s equity refers to the net value of a business or the money left over for stakeholders, owners, and executives, after paying all liabilities. It equals the sum of the total assets minus the total liabilities. 

Retained earnings from treasury bonds, stocks, capital investments, and gains are also part of stakeholders’ equity. Profitable businesses have positive retained earnings, while those experiencing losses have a negative figure. 

Equity can help banks and financial institutions determine how solvent your business is and its ability to meet financial obligations. Lenders will assess this before approving you for business loans.

What is an Income Statement?

The income statement summarizes the financial health of your business during a specified period. Accountants also call it a profit and loss (P&L) statement. This statement categorizes a business’ revenue and expenses, with the difference between the two representing profit or loss.

An income statement helps business owners know whether they generate profit or loss during the statement period. The period could be monthly, quarterly, or yearly based on the business needs and personal preferences. A company’s income statement has two parts. 

• Operating portion – Includes revenue and expenses that come directly from the core operations. It may include the revenue obtained from selling products and services or costs incurred from product development.
• Non-operating portion – Includes revenue and expenses derived from activities that aren’t closely linked to core operations. Examples include profit from investments, dividend income, or expenses like interest payments and asset write-downs. 

In addition, there are two methods of documenting revenue and expenses in an income statement. 

Single Step Income Statement

The single-step income statement uses a simplified format to report net income. It uses a one-step subtraction method. To use it, you subtract all expenditures from the total revenue. 

• Net income = (Revenues + Gains) – (Expenses + Losses)

Most small businesses have less complicated core operations and accounting and prefer the single-step income statement.

Multi-step Income Statement

This statement is comprehensive compared to a single-step statement. It utilizes several equations to determine a company’s net sales. There are three formulas or steps used in the multi-step statements.

• Gross profit = Net income – Cost of products sold 
• Operating income = Gross profit – Operating expense 
• Net income = Total operating income + Non-operating income

Large and complex companies often use this option since they have many different sources of revenue, employees, and activities. Small businesses usually do not need to take this approach.

Balance Sheet Example

Here is an example of a balance sheet from Facebook. It is a condensed statement from the last quarter of 2020. 

Facebook has among the healthiest balance sheets, with the total assets adding up to $159,316,000. That is enough to clear four times the total liabilities, which add up to $31,026,000. The total stakeholder’s equity is impressive, totaling $128,290,000. 

From this statement, Facebook has a chance to be flexible by trying new things without suffering any long-term consequences if they fail. 

Income Statement Example

Below is an income statement example from Apple. The reporting period is from the second quarter of 2020, compared to 2019. It is a multi-step income statement, with figures represented in millions. It includes operating income and expenses.

The operating income adds up to $11,249,000, for Q2 2020, respectively, increasing from the same quarter in 2019. Finally, the total net sales are $58,313,000, and $150,132,000, for three-month and six-month periods. 

Comparing the total net sales with the previous year, Apple made significant improvements despite the pandemic.

Remember, Facebook and Apple are huge enterprises with complex accounting needs. An income statement or balance sheet for a small business will look much simpler. 

Balance Sheet vs. Income Statement: What Comes First?

The income statement comes first. By now, you know that income statements break down revenue and expenses. 

First, you need to know whether your business is making a profit or loss. If your revenue is positive, it means your business is profitable. Negative revenue means you are experiencing a loss. An income statement then gives you the information you need to generate a balance sheet.

Similarities Between Income Statements and Balance Sheets

When you look at balance sheets vs. income statements, there are some similarities. Each provides information about a company’s financial position. They offer core financial reporting, and any omissions or errors lead to inaccurate results for both statements. Investors also look at balance sheets and income statements to evaluate your ability to repay loans.

The two also follow a similar accounting cycle, with an income statement coming before a balance sheet. 

Ultimately, there is a lot that business owners can learn from balance sheets and income statements. A balance sheet provides a clear picture of what a business currently owns and owes. An income statement records the revenue and expenses for a specific period. These financial statements are crucial in helping you make strategic choices for the future.

If you need help getting your business finances in order, reach out to xendoo. Our online booking and accounting team can help your small business prepare and understand financial statements and more.