LET’S GET STARTED
- 1 Their Purpose at a Glance
- 2 What is a Balance Sheet?
- 3 What is an Income Statement?
- 4 Balance Sheet vs Income Statement: The Key Differences
- 5 What Do They Have in Common?
- 6 How Both Reports Benefit Your Business
- 7 Two Reports, One Financial Outlook
- 8 Looking For Help With Reporting and Business Metrics Tracking?
It takes more than one financial statement to describe your business’s financial position. It takes both a balance sheet and income statement to provide insight into your company’s overall financial status and profitability.
The balance sheet and income statement, as well as statement of cash flows are produced by companies to reveal their business activities, and profits and losses for each reporting period. These reports also provide a look into the company's finances, its profitability, and summarize the values of the accounts in its bookkeeping system.
So what are the major differences between the balance sheet versus the income statement?
Their Purpose at a Glance
Both the balance sheet and income statement are essential documents for conducting business. A company with a vibrant and robust income statement will typically also have a good balance sheet, but it is possible for one of them to be shaky while the other is solid.
Investors and creditors pay particular attention to the balance sheet to determine how well management is utilizing the company's resources. The balance sheet records assets, liabilities, and shareholders’ equity.
The income statement, also known as the profit and loss statement, lists the revenues, costs, and expenses over a period, usually a fiscal quarter or a fiscal year. The income statement shows if a company is profitable or operating at a loss. Also, investors can glean information from the income statement about revenue, sales, and expenses.
What is a Balance Sheet?
The balance sheet is a financial statement that shows the business owner what he or she owns (assets), his or her debts (liabilities), and what remains (owner’s equity) at the end of an accounting period.
Assets include cash on hand, inventory, and property. Companies usually list these items by order of liquidity, meaning the assets that can be most easily exchanged into cash are placed highest on the list.
Liabilities include the company’s financial debts or obligations. These include taxes, loans, salaries, accounts payable, etc. Equity refers to the money that was originally invested in the company by the founder, as well as retained earnings after subtracting any distributions presented to owners.
Understanding a balance sheet requires learning the accounting equation: assets, on one side, equal equity plus liabilities, on the other.
Assets = Liabilities + Equity
The formula is easy to understand: A company must pay for its possessions such as equipment and factory (assets) by either taking out a loan (a liability), obtaining funds from an investor (i.e., issuing shareholders’ equity), or appropriating it from retained earnings.
For example, if a company borrows a 10-year, $12,000 loan from the bank, not only will its liabilities grow by $12,000, but so will its assets. If the company takes $10,000 from investors, its assets will increase by that amount, along with its shareholders’ equity.
$22,000 (Assets) = $12,000 (Liabilities) + $10,000 (Equity)
$22,000 (Assets) = $22,000 (Liabilities + Equity)
For the balance sheet to be in balance, the company’s total assets must equal total liabilities plus equity.
The balance sheet specifies how a company places its assets to work and how those assets are financed as indicated in the liabilities section. Banks and investors examine companies' balance sheets to determine how companies use their resources, so business owners should update them each month.
What is an Income Statement?
Corporate leaders require accurate financial information about their company’s finances to make major financial decisions such as plans to expand or to become a public company. In comparing a balance sheet versus an income statement, the income statement, or a profit and loss statement, presents crucial information about revenue, sales, and expenses. The phrase "bottom line" includes a company's earnings, profit, net income (also known as net profit), or earnings per share (EPS). The reference to the bottom line refers to the placement of the net income figure on a company's income statement. In short, it reveals a company’s financial condition during a specific point in time.
There are several income statement formats, but they all comply with the income statement formula:
Revenue - Expenses = Net income
A traditional income statement provides information about revenue, expenses, and net income or net profit in either a simple or multi-step format. The multi-step income statement splits business operations from other activities, such as investing. The more detailed format provides readers with an understanding of your company’s true condition, separate from your business investments.
Businesses must scrutinize revenue and expenses closely to maintain costs under control while still expanding revenues. Day-to-day expenses, or operating expenses, refer to costs of running a business and include everything from employee wages, research and development, copy paper, and utilities. For example, a company could be experiencing robust sales, but if costs are expanding faster than revenue that could cause the company to lose money.
In fact, the operating section of the income state is observed closely by investors and lenders to ascertain if a company is generating a profit or loss for the period. Along with providing crucial information, the operating section reveals if the company’s management is efficient and if the company’s performance exceeds or underperforms industry peers.
There are a few differences in terms of the information provided by a multi-step income statement. For example, the multi-step includes gross profit, the difference between sales and cost of goods sold, and also includes operating income.
Just by itself, the income statement as a financial statement lacks vital business information. For example, the income statement can report a net operating loss, but typically not what caused it.
The income statement also does not clearly delineate a company’s debt. Even if revenues may be robust if the business is facing a large debt payment and insufficient cash to pay it, the company could be in a precarious position.
Balance Sheet vs Income Statement: The Key Differences
The balance sheet and income statement are both financial statements that provide information about a business’s track record of performance, but the main difference in their reporting is the timing of the two different reports.
When comparing a balance sheet versus an income statement, it is important to consider that the balance sheet tells the story of a company’s assets, liabilities, and equity frozen at one stage in time, while the income statement reveals a company’s performance over a period of time, typically a month, quarter or year.
Another major difference between the two is that the income statement accounts are readjusted in the accounting cycle as revenue and expense accounts are closed to zero at year-end. Therefore, your business can begin anew in the next year. As part of the closing process, all revenue and expense account balances are marked down to zero.
There is no commonality in the balance sheet and income statement accounts, but net income is on the balance sheet as a portion of retained earnings, which is an equity account.
The differences between the income statement and balance sheet include the following:
- Timing: The balance sheet reveals a company’s assets and debts (liabilities) at a certain moment in time, while the income statement indicates total revenues and expenses for an exact time period such as a month, quarter, or year.
- Performance: The balance sheet does not present performance, only the income statement.
- Reporting: The balance sheet describes or reports assets, liabilities, and equity, while the income statement conveys data about revenue and expenses.
- Usage: The balance sheet is closely monitored by the company to determine if there are sufficient assets to take care of financial obligations. The income statement is used to gauge performance and to determine if there are any financial issues that must be improved or corrected.
- Creditworthiness: Lenders analyze the balance sheet to determine if they should extend additional credit to the company, but they also use the income statement to evaluate if the business is generating enough profit to meet its liabilities.
What Do They Have in Common?
The income statement and balance sheet have several differences, but they do a few things in common. Together with the cash flow statement, they comprise three major financial statements. Even though they are analyzed and evaluated in separate ways, they are both examined by creditors and investors when determining whether or not to extend credit to the company or invest funds in it.
Another way to compare the balance sheet versus the income statement is by noting that the income statement and balance sheet of a company are linked through the net income for a period and the subsequent growth, or decline, in equity that results. As a result, the income that a company generates over a specific period of time is noted in the balance sheet’s equity segment.
The income represents an increase in the owners’ claim against the assets. However, income is not considered a cash asset. It is via the income and equity accounts that the balance sheet and income statement reflect a company’s overall financial depiction.
How Both Reports Benefit Your Business
Financial statements provide information about the status of your company, i.e., what divisions or groups are functioning well, and which sectors are underperforming. The goal is to use the information to pinpoint nonperforming areas and to rectify the issues in order to accomplish the company's goals.
When comparing the balance sheet versus an income statement, it is important to remember that a balance sheet provides a picture of the company's assets and liabilities at a set point in time. It includes a company's assets in cash balances, accounts receivable, inventory, and fixed assets, including real estate holdings, plant buildings, and all equipment.
On the liabilities side of the balance sheet are the company's debts — both short- and long-term — and total equity capital. The balance sheet is analyzed by managers to ascertain a company’s liquidity and financial leverage. On a balance sheet, there is a list of current liabilities are short-term financial obligations that are usually due typically in a year. Current liabilities are listed on the balance sheet and are paid from the revenue generated from a company's operations. The balance sheet also has an account on the asset side that lists the company's investments such as stocks, bonds, real estate, and cash. Long-term investments are considered to be assets that a company will retain longer than a year.
As far as the income statement, or profit-and-loss statement, it presents total revenues and total expenses over a designated time period. Accountants typically compile income statements each month, quarter, and year. The goal of any business is to generate a profit and the income statement reveals if the company is achieving that goal. The income statement adds up the company's revenues and deducts expenses. The remainder is either a profit or loss.
Managers utilize the income statement to know their company’s profits and expenses. It is crucial for managers to know how their companies are performing and whether it is generating a profit. If a company is not profitable, executives must investigate and discover what is causing the losses or the company may have to declare bankruptcy. Basically, the income statement evaluates if the products and/or services offered by your company are profitable, after subtracting expenses related to managing the business.
Without knowing the true trends over time, you have to settle looking at inventory balances and gross profit margins that do not reveal the true picture about your company’s performance, and you are in the dark about the money entering or exiting your business.
Two Reports, One Financial Outlook
When comparing the balance sheet versus the income statement, it must be emphasized that both financial statements are crucial to analyze a company’s operations. The balance sheet shows what a company possesses (assets) and debts (liabilities), as well as long-term investments. Investors analyze the balance sheet to learn how management utilizes debt and assets to generate revenue that is transferred to the income statement.
The income statement reveals a company’s financial picture and whether a company is profitable. Both revenue and expenses are watched carefully. Management must expand revenues while ensuring that costs are kept under control. For example, revenue might be increasing, but if expenses are rising faster than revenue, the company could suffer a loss for the quarter or year. In addition, investors and analysts closely monitor the income statement’s operating section to track management's performance.
Overall, the balance sheet and income statement are closely analyzed to obtain a complete view of a company's current financial health and future potential to grow revenue and profits.
Looking For Help With Reporting and Business Metrics Tracking?
The reality is most business owners do not know which business metrics they should be monitoring and at what frequency. If you do not know your business’ metrics, then how can you make timely adjustments to help improve your business’s profitability?
Punch works with the team to help identify the metrics to measure, how to measure them, and how to report them in a timely manner so corrective business decisions can be made. A pilot cannot fly a plane without instruments to tell him/her key metrics like speed, direction, and altitude.
Our goal is to help create management dashboards to help you manage your business’s performance. What will you measure? Who will do it in the organization? How often? What tools should be used?
Let’s connect to give you a customized quote and free consultation. You have nothing to lose but so much to gain.