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January 10, 2022

The difference between the balance sheet and income statement

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Main accounting reports

Bookkeeping and accounting are meant to fulfill various needs of the users of the information they generate. Therefore, it should contain data on the financial and economic activities, as well as on the current state of the entity and changes in it for the reporting period.

One of the main advantages of accounting as a means of communication is its analytical capabilities. Its importance is predetermined by the fact that the financial reports of entities, the reliability of which is very high and, under certain conditions, confirmed by an independent audit, become an essential element of information support for the analysis of financial and economic activities. It is the financial documents that allow you to get the first and fairly objective idea of the state and trends of changes in the potential counterparty or investment object.

As soon as it comes to accounting, managers and owners remember three basic financial statements, which are a must-have for any business. But unfortunately, for the most part, they do not know how to properly analyze and compose them. Today, we are going to explain and look at the Balance sheet vs. Income statement.

The difference between the balance sheet and income statement

Balance Sheet

This document shows the property and financial condition of an organization in monetary terms. It contains data as of a specific date. This fundamentally differs the Balance sheet from another important form of reporting, which we are going to discuss in the next section of our article. This document includes assets and obligations, the totals of which are equal. Two subsections are created in the asset section:

  • current assets (raw materials, supplies, short-term receivables, and anything that stays on the books for less than 1 year)
  • non-current assets (buildings, vehicles, intangible assets, long-term investments, and anything that stays on the books for more than 1 year).

If the asset section of this report presents what property the company owns, then the obligations or liability side discloses the sources of formation of this property. It consists of three sections:

  • short-term liabilities (current obligations before employees, suppliers, etc. debts payable within 1 year)
  • long-term liabilities (loans and other debts due in more than 1 year)
  • capital and reserves (funds of whoever the entity belongs to).

Only this particular document can help you find the answers to some of the questions that might arise, so let’s review some of the potential situations that it might be useful for.

  • How much dividends can be withdrawn. It might seem that you actually need the report on profits to see how much to distribute. However, it can only tell the amount of income you can use and there is no information about your debts, where the profits might need to be directed first. The debt amounts along with accumulated earnings (loss) that can be used for dividends can only be received from this accounting report.
  • Where the “cash” is hidden. In a situation when the company reported a good profit, but there is little cash on the account, this document can reveal where they are “buried”. Frequently, profits are frozen in inventories and receivables (everything that others owe you).

For instance, a company received $50 thousand, of which $12 thousand were spent on raw materials for the production of a new batch of goods. For products worth $18 thousand, which has already been shipped to the client, the company will receive the payment only next month. Therefore, there is only $20 thousand on the account, and $30 thousand are frozen: $12 in Inventories and $18 in Accounts receivable. This is easy to see if you not only have access to the information on profits but also on the company’s assets.

  • How truly successful the entity is. It is possible to come across a situation where a company is making great profits and even owns real estate, transport, equipment, etc. It gives possibly an illusion of a successful entity. Why? All the significant assets could have been acquired thanks to loans, which still need to be fully repaid. Thus, it might turn out that when loan payments become unbearable, it will go bankrupt.

Income Statement

The second report we are going to talk about and compare with the first one discloses no less important financial indicators of the organization, such as how much it is making, how much it costs it to make the goods, various other spendings along with the bottom line everyone is so interested in.

Unlike the document we just talked about, where data is created as of a specific date, this document contains information for a period on an accrual basis typically starting from the beginning of the year (or for any other period, such as quarter, half a year, etc.).

The main indicators of the organization’s activities are at the very beginning of the report. These are revenue, GOGS, and operating expenses. All this constitutes the financial outcome of sales or the main activity of the organization, for the sake of which it was created.

Further, there are indicators of other income and expenses, which together with the previously obtained results from sales constitute the indicator “Profit before taxation”. After you deduct the amount of taxes, the final financial result is obtained. This would be your net profit or loss.

This report helps answer several questions that can help management and investors come to the right conclusions:

  • How have the income and spendings changed from one year or quarter to the next?
  • What is the structure of gross profit, COGS, etc.?
  • What factors have affected the final financial outcome?

By looking at the data from the report and thoroughly, you can identify opportunities for increasing the organization’s revenue and increasing its profitability.

Relationship of financial documents

From what you have read above, it might seem that we can only point out the differences between two accounting documents or the Balance sheet vs Income statement. After all, there are no account values that are directly transferred from one statement to another, for instance, net income value from the Income statement becomes one of the lines in the report on cash flows.

These two financial documents are by no means substitutes for each other, since they perform different functions. The Balance sheet, as already mentioned, shows the state of the company at one time or another. If you want to see what led to that state, you would pull out the report on profit and losses. Yet, there is a direct link between the two reporting forms.

The Income statement links the two consecutive Balance sheets. So, at the beginning of a new reporting period, the second one shows the original position of the entity. After some time, a new Balance sheet is prepared to see a new position, while the Profit and loss statement is compiled to provide data on what caused these changes since the date of the previous report. Of course, you will need other reports as well to see what exactly was happening during the time frame.

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Author: Charles Lutwidge

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