For each financial year, companies produce three major financial statements that reflect their business activities and profitability. These are the balance sheet, the income statement and the cash flow statement. The cash flow statement shows how well a business manages its cash flow to fund operations and expansion efforts. The balance sheet and the income statement detail the financial accounting of a company. The balance sheet details the assets and liabilities of a business, while the income statement details the income and expenses of the business. Focus on the balance sheet and the income statement and their differences.
What is a Balance Sheet?
The balance sheet is a snapshot of what the business both owns and owes at a particular time period. It allows, along with the other documents mentioned in this article, to carry out a financial analysis of the company. The purpose of a balance sheet is to show the net worth of a business and an overview of its financial position at a given point in time.
Investors and creditors analyze the balance sheet to assess how management is using a company's resources. The balance sheet presents assets, liabilities and equity. Total assets should equal the sum of total liabilities and equity. Liabilities reflect how these assets are financed. Equity is the difference between assets and liabilities - the money that would remain with shareholders if the company paid off all of its debts.
What is included in a balance sheet?
The balance sheet is therefore a financial statement made up of assets, liabilities and equity that is produced at the end of the accounting period.
- Assets include cash, inventory and property. These items are generally listed in order of liquidity.
- Liabilities are the debts and financial obligations of a business. They include things like taxes, loans, salaries, accounts payable, etc.
- Equity is the amount of money initially invested in the company plus retained earnings less distributions paid to owners and shareholders.
A business has to pay for everything it owns (assets) either by borrowing (liabilities), borrowing it from an investor (issuing equity), or drawing it out of retained earnings.
The total assets of the company must equal the total liabilities plus equity for the balance sheet to be considered balanced.
The balance sheet shows how a company puts its assets to work and how those assets are funded based on the liabilities section.
Banks and investors analyze a company's balance sheet to see how it uses its resources, before granting a loan or becoming a shareholder. To better analyze the key areas of the balance sheet, here are the elements taken into account by investors:
- Current assets, which are short-term assets typically used within the year or less,
- Long-term assets,
- Current liabilities, short-term liabilities due within one year,
- Long term liabilities,
- Shareholder's equity
What is an income statement?
The income statement, also called the profit and loss account, reflects the financial health of a business over a given period. It also provides valuable information on the income, sales and expenses of the companies and hence is used during important financial decisions.
Monitoring income and expenses helps keep costs under control while increasing income. When a business's income increases, if the expenses increase faster than the income, the business can lose profits.
Investors and lenders pay close attention to the operating section of the income statement to determine whether or not a business is making a profit or a loss. Not only does it provide valuable information, but it also shows how efficiently the company is running and how well it performs against its competitors.
What is included in an income statement?
This document reports revenue, cost of goods sold and operating expenses, as well as the resulting net income or loss for that period.
An operating expense is an expense that a business incurs on a regular basis, such as the payment of wages, rent, and unfunded equipment.
A non-operational expense is not linked to major business operations such as depreciation or interest charges.
Operating income is income generated by core business activities, while non-operating income is income not related to these core business activities.
The main differences between balance sheet and income statement
It is important to note all the differences between the income statement and the balance sheet in order to know which of the two documents to take depending on the information sought.
The balance sheet shows what a company owns (assets) and owes (liabilities) at a given time, while the income statement shows the total of what it has earned and that of expenses for a given period.
The balance sheet does not indicate the business performance of the company, it is the role of the income statement.
The company uses the balance sheet to determine if the company has enough assets to meet its financial obligations and the income statement to assess performance and to detect possible financial problems that need to be corrected.
Lenders use the balance sheet and income statement to see if they should give a loan. The balance sheet shows the credit needs, the income statement, whether or not the company is making enough profit to pay its debts.
What do the balance sheet and the income statement have in common?
Although the income statement and the balance sheet have many differences, they have a few things in common.
Together with the cash flow statement, they constitute three major financial statements.
They are used by both creditors and investors to help them decide whether or not to get involved in the business.
They provide a good indication of the current and future financial health of a business.