Income Statement VS Balance Sheet
Learn the key differences between a company’s balance sheet and income statement.
Balance Sheet vs Income Statement Summary
What is a Balance Sheet?
A balance sheet is commonly referred to as a “snapshot in time” where you can see what a business owns and owes at a single point in time.
The core equation for the balance sheet: Assets = Liabilities + Shareholders’ Equity.
Assets
The assets section contains valuable items or resources that are linked to the business. Typically, this section is split into 2 sections with current assets and current liabilities.
Current Assets: Short-term assets that can be converted into cash within one year.
Example Current Assets:
- Cash
- Inventory
- Accounts Receivables
Non-Current Assets: Long-term assets that typically cannot be converted into cash within one year.
Example Non-Current Assets:
- Property, Plant, Equipment (PP&E)
- Long Term Investments
Liabilities
The liabilities section contains figures that track company debts. Similar to the assets section, the liabilities section is split into current liabilities and non-current liabilities.
Current Liabilities: Short-term debts that the company expects to pay off within one year.
Example Current Liabilities:
- Accounts Payable
- Accrued Expenses
- Current Portion of Long-Term Debt
Non-Current Liabilities: Long-term debts that are due after 1+ years.
Example Non-Current Liabilities:
- Long Term Debt
- Other Long-Term Liabilities
Shareholders’ Equity
The shareholders’ equity section tracks how much stock investors have invested in the company. There are typically 2 important line items in this section: a company's share capital and retained earnings.
Share Capital: Represents money the company has received through the direct sale of stock to equity investors.
Retained Earnings: Accumulated earnings that have been reinvested into the company.
Why is the Balance Sheet Important?
The balance sheet is important because it allows investors and financial analysts to track the financial status of a company. This is typically done through financial ratios used to check balance sheet figures.
There is a range of different ratios that can be used to evaluate company health and performance. This includes profitability ratios, liquidity ratios, leverage ratios, and more. Some ratios will use just balance sheet items while others will use a mix of balance sheet and income statement items.
Example:
If you wanted to measure the short-term risk of the company, you could do that by taking current assets and dividing by current liabilities. The idea here is that if your current assets outweigh your current liabilities, the company is less likely to be at risk of being unable to pay back its short-term debt. This ratio is known as the current ratio.
What is an Income Statement?
A company income statement measures how profitable a company is over a period of time. Unlike the balance sheet which represents a snapshot of a single moment in time, the income statement is a range that covers the revenue and expenses that took place from year to year.
Simply put, the income statement can be represented by this formula: Revenue - Expenses = Net Income.
To learn more details about the income statement, check out this article: How to Prepare an Income Statement.
Why is the Income Statement Important?
The income statement is important because it is used to measure profitability. A healthy company should have healthy profit margins that deliver a strong amount of income relative to company expenses.
The income statement more specifically allows you to identify and question the potential profitability improvement points within a business.
- Can gross profit be improved? If so, do we need to increase sales (revenue) or decrease the costs required to make the product or service (COGS)?
- Can operating income be improved? Are we spending efficiently on rent, sales, marketing, etc.
- Can pretax income be improved? Are we paying a fair amount of interest on our debt? Should we use less debt? Can we find better interest rates on other loans?
- Can net income be improved? Are we paying too much in taxes? Can we restructure the business to reduce corporate taxes?
The Difference Between the Two Financial Statements
To recap and summarize, the balance sheet and income statement are both important and different financial statements that can be used together to evaluate the health of a company.
Balance Sheet: What a company owns and owes at a single, frozen point in time.
Income Statement: How profitable a company is when subtracting expenses from total revenue.
The Benefits of Having Both
It is advantageous to look at both the balance sheet and the income statement as you can use these two statements to figure out how much cash is flowing into the business through the statement of cash flows.
To learn how to create a statement of cash flows using a company balance sheet and income statement, check out this article: Build a Cash Flow Statement.
Additional Resources
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