The Difference Between an Income Statement and Balance Sheet Explained
An income statement and a balance sheet are two important financial documents in any business. They provide critical information about a company's financial health and performance. While both statements offer valuable insights, a thorough income statement vs. balance sheet comparison reveals some key differences. Here's a closer look at both documents.
What Is a Balance Sheet?
The balance sheet provides a snapshot of a firm's assets, liabilities, and shareholders’ equity at a specific point in time. This information is used to assess the business' finances and its ability to pay creditors.
The balance sheet is used by investors and analysts to understand a company's risk profile. If you own a small business, you can use accounting software to manage the balance sheet.
What Goes on the Balance Sheet?
A balance sheet includes a company's assets, liabilities, and the owner’s equity.
Assets are everything that a company owns and can use to generate income. This includes cash, investments, accounts receivable, inventory, property, plant, and equipment.
There are two types of assets on a financial balance sheet: short-term and long-term. Short-term assets, also known as current assets, are those that can be converted to cash within one year or less. Since the assets on a balance sheet are listed in order of their liquidity, the short-term ones come first. These include cash, accounts receivable, and inventory.
Long-term assets are those that cannot be converted to cash within a year. These are items like property, plants, and equipment. Long-term assets are also intellectual capital and trademarks. They are listed right below current assets on the balance sheet.
A liability is anything a company owes to another party. This can include taxes or money owed to suppliers, employees, and creditors.
Liabilities are typically divided into two categories: current and long-term. Current liabilities are those that are due within one year, like accounts payable and taxes payable.
Long-term liabilities are those that will take longer than a year to pay off, including long-term loans, mortgages, and car payments.
Understanding a balance sheet also requires familiarizing yourself with shareholder equity. This refers to a portion of the firm's assets owned by its shareholders and listed on the shareholders’ equity statement. This can include common stock, preferred stock, and retained earnings. Equity is also sometimes referred to as net assets.
What Is the Purpose of a Balance Sheet?
The purpose of a balance sheet is to tell interested parties what the business is worth from a book value perspective.
The liabilities section of the balance sheet reveals how a firm puts its assets to use and how those assets are financed based on the company's financial obligations. A company's total assets should be equal to the sum of its total liabilities and shareholders’ equity:
Assets = Liabilities + Shareholders' Equity
Banks and investors examine a firm's balance sheet to see how it utilizes its resources, which is why it's critical to keep them up to date.
The balance sheet differs from the income statement in a number of ways.
What Is an Income Statement?
An income statement is a financial statement that reports a company's financial performance over a specific accounting period. It is often referred to as the profit and loss statement or P&L.
What Goes on the Income Statement?
Unlike a balance sheet, P&L shows a company's income and expenses for a given period of time. It computes the net income, which is the difference between a company's total revenue and total expenses for a certain period.
Generally, a company's income statement includes the following items:
Revenue is money earned by a company during a specific period of time, typically from the sale of goods or services. Revenue consists of operating revenue and non-operating revenue.
Operating revenue is the main source of revenue for a company and comes from the company's core business activities. Non-operating revenue is generated from other activities, such as interest income or gains from the sale of assets.
P&L or an income statement also shows the firm's expenses. Expenses are the costs incurred by a company to generate revenue. They include both operating expenses and non-operating expenses.
Operating expenses are the costs associated with a company's core business activities, such as the cost of goods sold (COGS), selling, general and administrative (SG&A) expenses, and research and development (R&D) expenses.
Non-operating expenses are costs not associated with a company's core business activities, such as interest expenses or losses from the sale of assets.
This is the bottom line on the income statement and represents a company's total revenue minus total expenses. It can be either positive, meaning the company made money, or negative when the company loses money.
What Is the Purpose of an Income Statement?
Together with a balance sheet, an income statement paints a clear picture of a company’s financial performance. By providing information on a company's revenue, expenses, and profits, the statement is used to assess the profitability of a business.
Income statements are typically prepared on a quarterly or annual basis. Investors, creditors, and analysts use income statements to evaluate a company's past performance and current financial position.
Similarities Between Balance Sheets and Income Statements
There are a few key similarities between a balance sheet and an income statement. Both provide insights into the overall financial health of a business.
The balance sheets show assets that can be used to pay its debts, while the income statement shows a company's operating cash flow, which is another source of funds for paying debts.
Finally, both statements can be used to calculate important financial ratios, such as the debt-to-equity ratio, which is a key metric for assessing a company's financial situation.
While there are some similarities between those two financial documents, there are also some important differences.
Differences Between an Income Statement and Balance Sheet
Below are the most important distinctions between these crucial financial documents.
- The income statement records a company's revenue and expenses over a given period of time, typically one year. The balance sheet, on the other hand, provides a snapshot of the business' assets, liabilities, and equity at a single point in time.
- The income statement is used to assess a company's performance over time. The balance sheet can't be used for evaluating performance.
- While the income statement reports revenue and expenses, the balance sheet reports assets, liabilities, and equity.
- Another difference between an income statement and balance sheet is creditworthiness. Banks and creditors check on balance sheet items when they are considering lending money to a company. They want to see that the company has enough assets to repay the loan and that the company's liabilities are manageable.
- Finally, the income statement is used to generate tax reports, while the balance sheet is not.
When making the balance sheet vs. income statement comparison, the most important thing to know is that those are two of the most critical business documents. They provide essential information about a company's performance and the value of the business. While both statements are useful, they serve different purposes and should be used in conjunction with each other to get a full picture of a company's financial situation.
What is the difference between an income statement and a balance sheet?
An income statement, also called a profit and loss statement, reports a company's financial performance over a particular period of time. A balance sheet, on the other hand, provides a snapshot of a company's financial position at a single point in time.
Which is more important: the income statement or the balance sheet?
Both the income statement and balance sheet are important, but they serve different purposes. The income statement is used to assess a company's financial performance, while the balance sheet provides insights into its financial position.
How are balance sheets and income statements related?
The balance sheet offers information on how much the business is worth in terms of assets, liabilities, and equity, while an income statement details the revenue and expenses.
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