• Balance sheets and income statements are invaluable tools for business owners to measure their company’s performance and prospects, but they differ in important ways.
  • A balance sheet provides a snapshot of a firm’s financial position at a specific point in time, while an income statement — also known as a profit and loss statement — measures performance over a period of time.
  • Accounting software helps to manage both these financial statements.
  • This article is for small business owners who want to understand how to use the balance sheet and income statement.

The balance sheet and income statement are important tools to help you understand the health and prospects of your business, but the two differ in important ways. This guide will give you a comprehensive overview of both the financial statements.

Balance sheets and income statements represent important information about the financial performance and health of a business. An income statement measures the profit or loss of a business over a period of time, whereas a balance sheet shows the financial position of the business at a specific point in time.

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Balance sheet and income statement complement each other in providing a complete picture of a company’s financial position and future prospects. Both are important to decision makers, investors and financial institutions.

These terms may seem daunting at first if you don’t have an accounting or finance background, but reading and analyzing financial statements is an essential skill for business owners and executives.

What is Balance Sheet?

The balance sheet is the cornerstone of a company’s financial statements, providing a snapshot of its financial position at a given point in time.

This includes what the company owns (its assets), what it owes (its liabilities), and owner’s equity, which includes money initially invested in the company, as well as any retained dues due to owners or shareholders. with earnings.

This statement is divided into two columns based on the following equation:

Liabilities + Shareholder’s Equity = Assets

This equation forms the foundation of a balance sheet, with assets in one column, liabilities equal and owner’s equity in the other.

The balance sheet shows the company’s performance since its inception, showing each transaction, amount raised, accumulated debt, assets acquired and their current valuation, all presented in a single statement.

It provides insight into a company’s operations, finances and future prospects using financial ratios such as debt-to-equity, which reflects a company’s ability to pay off its debts using equity or the current ratio, which Divides current assets by current liabilities. Determination of the company’s ability to meet its obligations over the next 12 months.

did you know?did you know? The acid-test ratio adds further clarity to the current ratio by considering only easy-to-liquid assets, providing a more accurate picture of a company’s ability to meet its obligations.

What is included in the balance sheet?

The balance sheet includes assets, liabilities and owner’s equity at the end of the accounting period.

properties

  1. Cash and cash equivalents: Listed under current assets, this figure represents the value of cash held by the company with other cash equivalents at the end of an accounting period, which may include marketable securities and short-term deposits.
  2. Accounts Receivable: It is the amount owed to a company for goods and services delivered but not yet paid. It can be used as collateral to borrow money and is listed under current assets on the balance sheet.
  3. List, It refers to raw materials for the production of goods or services as well as finished goods ready for sale. Inventory is also classified under current assets.
  4. Plant, property, intellectual property and more: These are long-term investments that cannot be turned into cash quickly, are not used directly in the production process, and have a life of more than one year. Such assets may include trademarks, copyrights and goodwill. They are depreciated or amortized based on use or value. On the balance sheet, they are listed under non-current assets.

liabilities

  1. Debt: A loan is an amount owed to lenders, banks or suppliers. They can be classified as either current liabilities or non-current liabilities, depending on whether they are long-term or short-term debt. Even for long-term loans, future payments are included under the current portion of long-term debt.
  2. Accounts Payable: It is the payment owed by the company to the suppliers or vendors for the goods and services delivered. Given the short-term nature of these obligations, they are classified under current liabilities, which are often payable within 90 days.
  3. Underfund Pension Scheme: Company-sponsored retirement plans with more liabilities than assets are considered under-funded plans for those unable to meet their current or future obligations. They are often classified as a non-current liability, and the company is obligated to make payments and fill in the gaps when required.
  4. deferred tax liability: It represents taxes that have been earned but have not yet been paid. Deferred tax liability often arises from the difference between the time when tax is due and when payment is due, in the circumstances of installment sales, or to make up for the accrual/cash time difference.

owner’s or shareholder’s equity

In simple words, owner’s or shareholder’s equity equals the total assets attributable to the owners or shareholders in the event of the company’s liquidation, after all debts or liabilities have been paid.

This section of the balance sheet includes the return of equity (ROE) calculated by dividing net income by shareholder’s equity. ROE measures management’s effectiveness in planning and driving returns based on equity.

Shareholder’s equity also includes retained earnings—the portion of net income that is not distributed to shareholders as dividends—that will be used to finance the further growth and expansion of the business.

significant achievementsFYI: Management typically aims to maximize return on equity, and return money to shareholders in the form of dividends or share repurchases when it is unable to generate sufficient returns with these retained earnings.

What is an Income Statement?

Also known as a profit and loss (P&L) statement, the income statement summarizes a business’s financial performance during a specific period, reporting revenue, cost of goods sold, overheads, and net attributable to shareholders. the gain.

The P&L statement is one of three major financial statements issued by a business, either quarterly, annually, or both if it is a public company. It keeps track of profitability, income sources, expenses and budgets, allowing the company to take action against variances from estimates. Investors and lenders pay attention to the P&L statement, especially when comparing different periods to determine a company’s long-term trajectory.

For a skilled analyst, the data presented in the profit and loss statement can provide deeper insights with the use of ratios. These include gross and operating margin ratios, which highlight a company’s profitability in relation to sales and expenses incurred; cost-earnings and return-equity ratios to assess efficiency in capital allocation; and the time-interest-earned (TIE) ratio for a company to meet its debt payments to measure the margin of safety.

What is included in the income statement?

The income statement focuses on four major items: sales revenue, expenses, profit and loss. It is not related to cash or non-cash sales, or anything with respect to cash flows.

  1. Revenue: This includes money generated from normal business operations. This is the company’s top line, and represents the total income generated during a specific period. It is further divided into operating revenue, or revenue generated from the core activities of a business, and non-operating revenue, which includes non-core sources such as interest income and rental earnings.
  2. Actual Profit and Loss: Also known as “other income,” these are lump-sum, non-recurring gains that result from the sale or disposal of assets. These may include the sale of real estate, a minority stake in other firms, or even a subsidiary. On the other hand, the sale or disposal of loss-making assets is listed under “other expenses” and is often the result of selling assets at prices lower than their valuation on the balance sheet during a specified period.
  3. Expense: This includes all costs arising from the normal course of business, such as cost of goods sold (COGS), which is the direct cost of materials and labor incurred during the production of goods and services. Expenses also include general administrative costs., Those that are not directly linked to the production process but are essential to the organization, and depreciation or amortization of assets based on use or fixed schedules.
  4. Net income (loss: The income statement ends in a net profit or loss during the period, also known as the bottom line. Net profit or loss is what remains after adding up the actual profit and subtracting the expenses and the actual loss. This figure is due to shareholders.

What are the differences between balance sheet and income statement?

Here is a quick reference to the main difference between balance sheet and income statement, which we have discussed above.

Balance sheet income details
time The balance sheet summarizes a company’s financial position at a specific point in time. The income statement provides an overview of a company’s financial performance over a given period.
key items This includes assets, liabilities and shareholder’s equity, which are further classified to provide accurate information. This includes revenue, expenses, and profits and losses derived from the sale or disposal of assets.
financial analysis It helps in assessing financial health by using ratios such as current ratio, debt-to-equity ratio and return on shareholder’s equity. Ratios such as gross margin, operating margin, price-to-earnings and interest coverage paint a picture of financial performance.
Experiment Investors and lenders use it to determine the creditworthiness and availability of assets for collateral. Management, investors, shareholders and others use it to assess the performance and future prospects of a business.

What are the Similarities Between Income Statement and Balance Sheet?

Balance sheet and income statement complement each other in painting a clear picture of a company’s financial position and prospects, hence they have similarities.

Along with the cash flow statement, they form the core of financial reporting. Error or omission in any one of them produces wrong result in all of them.

The income statement and balance sheet follow the same accounting cycle, in which the balance sheet is created immediately after the income statement.

If the company reports a profit of $10,000 during a period, and there are no drawings or dividends, that amount is added to the shareholder’s equity on the balance sheet.

These and other similarities make them interdependent and necessitate both in providing a clear and complete picture of the accounts.

Can Accounting Software Help You Manage Income Statements and Balance Sheets?

Given the importance of the income statement and balance sheet in financial reporting, accounting software is invaluable. This can reduce mistakes or omissions that would result in erroneous or incorrect financial statements.

There are many accounting tools and solutions that you can read about in our QuickBooks accounting software review or our FreshBooks accounting software review. There are accounting tools that cater to organizations of all types and sizes. Here are some of the best accounting software solutions with budget pricing and intuitive user interfaces that can make accounting less difficult.