The balance sheet report shows the company’s financial position at a certain point in time, while the income statement reports the period’s profit.
From a regulatory standpoint, a balance sheet and an income statement must be produced at the end of the accounting year. It is also possible to draw up a balance sheet and income statement at more regular intervals (monthly or quarterly) for internal business needs in practice.
This article covers:
What is the balance sheet (B/S)?
The balance sheet is a financial statement that shows how much property you currently own and shows your company’s safety. In B/S, stock information (financial status) as of the end of the fiscal year is divided into assets, liabilities, and net assets and expressed in a table format.
Assets refer to a company’s entire assets, such as cash and deposits and real estate. Debt refers to the entire obligation that a company must repay, such as debt. Net worth is the balance of assets minus liabilities and means the net assets held by the company.
Let’s explain cash, deposits, buildings, and borrowings as specific examples of accounts handled on balance sheets. Cash and deposits and buildings are the “assets” you currently hold. Borrowings, on the other hand, are “debt”. Let’s assume that cash and deposits are 8 million dollars, buildings are 12 million dollars, and borrowings are 9 million dollars. Then, the assets, liabilities, and net assets are as follows.
Assets: 20 million dollars (8 million dollars + 12 million dollars)
Debt:9 million dollars
Net assets: 11 million dollars (difference)
Now, we can see that we have a net property of 11 million dollars as of the end of the current fiscal year.
What is the income statement (P/L)?
The income statement (P/L) is a financial report that shows the business results for one year and shows profitability and growth potential. In P / L, income and expenses are displayed, and the difference is summarized in one table as net income. The money earned in the current year becomes profit, and the money spent becomes an expense.
Let’s explain sales, cost of sales, and land rent as specific examples of accounts handled on P/L. Sales are equivalent to “earnings” because they are the money you earn. On the other hand, sales costs and land rent are “expenses” because they are the money spent. Let’s assume that the sales are 8 million dollars, the cost of sales is 3.5 million dollars, and the land rent is 2.2 million dollars. Then, the income and expenses will be as follows.
Revenue: 8 million dollars
Cost: 5.7 million dollars (3.5 million dollars + 2.2 million dollars)
Net income: 2.3 million dollars (8 million dollars-5.7 million dollars)
In this way, by subtracting expenses from the annual revenue, the current year’s net income is specified.
What is the relationship b/w the balance sheet and the income statement?
Even though they are different, these financial reports are related to one another whose components cannot be separated.
Equity, which is part of the balance sheet, is increased by the part of the profit for the year that is not paid to the shareholders. Similarly, equity will be reduced if the company ends up with a negative result for the financial year.
The income statement, therefore, provides an overview of income and expenses in the financial year. In contrast, the balance sheet provides an overview of the company’s total value throughout the years at a given time (the year-end date).
Let’s systematically understand the relationship between the balance sheet and the income statement!
Let’s systematically understand the balance sheet and the income statement!
It is very important to systematically understand the relationship between the balance sheet and the income statement. Now, let’s consider one example based on the above points.
Suppose you establish a company with a capital of $1,000. At this time, the capital is $1,000, so the capital is $1,000. The money becomes the company’s assets as cash. Therefore, the asset cash is $1,000. The income statement isn’t working because the company hasn’t bought or sold (transaction) yet. In other words, it looks like this.
- Balance sheet
|Cash $1,000||Capital $1,000|
|Amount of sales||$0|
The following month, the company receives a $10000 loan from the bank. Borrowing is a liability, so the debt will increase by $10000, and the funds raised will be $10000 as assets of the company, all of which will be cash. And since the company isn’t buying or selling, the income statement movement remains zero. In other words, it is recorded like this.
|Cash $20000||Liability $10000 Capital $10000|
After that, the company sells the item for $800. If you sell it, you will get $800 in cash. In other words, the product will run out of $500 and will be cash instead. You also sold the one for $500 for $800, so the profit is $300. This profit will be capitalized as cash.
On the other hand, on the credit side, the profit of $300 is not the money borrowed or paid-in capital, so it is recorded in the item “Retained earnings”. If it is an expense rather than an income, it will be negative because the capital portion will decrease. And since there was a buying and selling movement in the income statement, we will reflect on the balance sheet’s movement. In other words, it looks like this.
|Cash $2300||Liability $1,000 Capital $1,000 Profit $300|
|Amount of sales||$800|
In this way, past profits and losses on the balance sheet are reflected in the income statement’s trading results.
What should we read first: the balance sheet or the income statement?
In general, we start by reading the income statement to assess the company’s economic performance over the last financial year.
After reading the income statement, we begin to read the balance sheet to assess the company’s financial situation at the closing date of the financial year.
The result links the balance sheet and the income statement for the year. The income and expenses appearing in the income statement are balanced at the end of the financial year. The resulting difference corresponds to the net income, which is then included in the balance sheet’s liabilities in equity.
Important information found in an income statement
The income statement provides in particular information on:
- The formation of the net profit for the past financial year, by breaking it down into several results (operating profit, financial profit, exceptional profit);
- The company’s turnover for the past financial year;
- The volume of purchases made by the company over the past financial year and the variation in its stocks;
- The company bears external costs;
- The company’s payroll and employer contributions;
- The cost of the company’s financing policy, in terms of financial charges;
- Expenses relating to unusual events, at the level of exceptional charges.
Important information found in a balance sheet
In particular, the report provides information on:
- The company’s equity. It includes the contributions in share capital and issue premiums, the reserves accumulated thanks to the performance of previous years, and the result for the closed year (which also appears at the bottom of the income statement);
- The composition of the company’s fixed assets and its (value of net fixed assets/value of gross fixed assets). The importance of this part of the balance sheet depends on the activity of the company. For production companies, the condition of fixed assets is essential. For service companies, it is often less so;
- The total amount of supplier debts, i.e., supplier invoices not yet paid at the year-end date. These must be settled after the end of the financial year;
- The total amount of tax and social debts, which corresponds to the sums remaining to be paid to the tax administration (VAT, corporation tax, etc.) and social organizations at the end of the financial year;
- The total amount of trade receivables, i.e., invoices sent to customers that have not yet been paid on the year-end date. These will be paid to you after the end of the financial year;
- The value of the company’s inventories at the year-end;
- The cash flow statement and any investments of the company at the end of the financial year.
What is the difference b/w the income statement and the balance sheet?
The balance sheet and the income statement are two important documents for a company. They look a bit similar because each has two columns, which must be balanced.
However, at least once a year, companies are obliged to compare their income and expenditure – be it the income statement for small companies or a comprehensive annual financial statement. It forms the bookkeeping conclusion, with the balance sheet and income statement representing important main components. Both offer transparency about the financial situation, but there are also one or the other difference:
A balance sheet of a company is divided into assets and capital and thus shows all the company’s stocks. In contrast, an income statement shows success by comparing expenses and income.
The balance sheet shows the financial security and stability of a company with the help of various key figures, such as the equity ratio. The income statement shows previous costs and sales, as well as profits received.
When it comes to calculating different values, you need a set of calculations in your income statement. You only need to collect all revenue and all expenses and subtract the total cost from the total income for profit or business loss.
The calculation of the owner’s equity on the balance sheet requires several calculations. For example, an entity must retain its assets from its owner in order to retain its ownership, and the assets must always be equal to the shareholder’s capital and liabilities. This ensures that the balance sheet is appropriately executed.
The primary purpose of preparing the income statement is to determine the company’s profit or loss from its business activities. Income and expenditure are divided into different categories, making it easier to determine the source of profit and loss. On the other side, the balance sheet is also called the statement of financial position, and its function is to provide an overview of the company’s position in its financial position.
As the term “balance sheet date” suggests, this is a snapshot of a single point in time in which all financial resources are shown. The difference here: in the income statement, the company is analyzed over a certain period, for example, a year or quarter.
However, the annual surpluses must match the income statement and the balance sheet at the end. Both are essential parameters in accounting – for you and your further planning, as well as for the third parties involved. Despite a difference in the list, they provide information about profitability and success and are therefore essential for proper bookkeeping.
Parts that are important and you need to know in the balance sheet.
You need to know that in making a balance sheet, the amount in assets always equals the number of liabilities (liabilities and capital). The balance of the two is described as an accounting equation, which is an equation that shows the amount of all listed assets as coming from the creditor, the owner. On the other hand, the amount contributed by creditors and owners must be the same as the number of assets in the company
- Assets are resources possessed by a company, which is usually calculated in units of money. The type of financial resources in the company is called the assets of the company. Of course, these assets consist of various kinds such as land, buildings, machinery, accounts receivable, prepayments (advances), etc. Usually, these assets are listed on the balance sheet, in a definite order, starting from current assets (cash, accounts receivable, inventories). After that, other assets such as assets that are permanent (land, buildings, machinery, and so on) will be followed.
- Liability, namely debt that is obligatory or must be paid by a company, with money or with services at a certain time. It can be said that liabilities are debts of creditors to a company, usually, first, a short-term obligation, such as trade payable, notes payable, is included. Then under short-term liabilities, there are long-term liabilities such as mortgage debt.
- Then for this capital, you also need to enter it in the balance sheet. And this part of capital is listed in the section below the obligations; this capital is a right that is owned by a company.
Important parts that you need to know in the Income Statement
A number of the things you should know in the profit or loss statement, namely. In this profit or loss statement, the title consists of a company’s name and is given the name of the report (income statement). This income or loss statement also includes the reporting period and the contents of the income statement. Therein consists of three main components, such as income, costs, profit, which means:
- Income is the flow of money or other assets that the company receives from one of the consumers. This results from the sale of company goods, not only that the company can also provide services to its consumers.
- Cost is one of the costs of goods or products and can also service. What is sold by a company by its consumers to earn or generate income.
- Profit or loss, namely the difference between more or less costs, from the operational costs or initial capital.
Detailed layout according to the Accounting Principles
- sales revenue
- other operating income
- cost of goods
- change in inventory of goods under construction and finished goods
- labor cost
- impairment of plant, property and equipment and intangible assets
- other operating expense
- operating profit
- income from investment in subsidiaries
- income from investment in another enterprise in the same group
- income from investment in associated companies
- interest income from companies in the same group
- other interest income
- another financial income
- change in value of market-based financial current assets
- write-down of other financial current assets
- write-down of financial fixed assets
- interest expense to companies in the same group
- Other interest expenses
- Other financial cost
- ordinary profit before tax expense
- Taxes on ordinary result
- ordinary result
- extraordinary income
- extraordinary cost
- tax expense on extraordinary profit
- fixed assets
- intangible assets
- fixed assets
- Financial fixed assets
- current assets
- Bank deposits, cash, etc
- equity and debt
- paid-in capital
- earned equity
- provision for liabilities
- Other long-term debt
- short-term debt
Why are balance sheets and income statements both important?
We have clarified the difference between the balance sheet and the income statement. It now remains to understand why it is necessary to include both in the financial statements.
Every action from the company’s management point of view must be reflected and therefore represented within the financial statements, translating it into numerical language.
Only by keeping track of every single event, even the smallest, that produces effects for monetary purposes, is it possible to achieve responsible management of resources and the entire company.
Balance sheets and income statements are essential for establishing a transparent financial situation, which will then determine the tax burden.
In addition to providing their data to the tax authorities, the balance sheet and income statement, therefore, the balance sheet is handy for keeping the situation under control.
Often entrepreneurs limit themselves, due to lack of time or lack of information, to completely delegating everything to the accountant.
However, this does not give him the possibility to control and intervene in real-time.
Structure of the income statement
- Total sales: Represents the value of goods delivered to customers, sold in cash or on credit.
- Profitability on sales: The value of the merchandise that customers return because they did not like it at all.
- Sales discounts: The amount for which discounts were granted on the sale prices of the merchandise.
- Purchases: It is the value of the goods purchased.
- Purchase expenses: These are the expenses that must be made to acquire the merchandise, for example freight, transport, insurance, loading, unloading, etc.
- Purchase returns: This is the value of the goods returned to the suppliers because we did not like them.
- Discounts on purchases: The amount for which we are granted discounts on the purchase prices of the merchandise.
- Initial inventory: The value of the goods in stock.
- Inventory closing: The value of the goods at the end of the year.
- Selling or direct costs: These are the expenses directly related to the sales process, for example, salaries of promoters’ staff, sellers, advertising and advertising, shipping costs, rentals and maintenance of buildings or commercial premises, depreciation and expenses maintenance of distribution equipment, etc.
- Administrative or indirect costs: These are the expenses necessary for the maintenance of the administrative area of the company, for example, salaries of administrative staff, rent, and maintenance of offices, stationery, telephone, electrical energy of the offices, depreciation expenses, and maintenance of equipment IT, office furniture and equipment, etc.
- Financial expenses and products: The expenses and income derived from the gains or losses in the foreign currency exchange, the interests paid or paid by the entity, the bank commissions, etc.
- Other expenses and other products: These are the expenses or income derived from unusual operations for the entity, for example, gains or losses from the sale of fixed assets, income collected, purchase and sale of shares, etc.
Structure of the balance sheet
The balance sheet’s basic structure is theoretically based on the accounting balance formula of “assets = liabilities + owner’s equity”. The left side of the sheet is the company’s assets; that is, the company’s various economic assets in its commodity operations. Resources. The right side of the sheet is the capital invested by the company’s investors (creditors, equity holders) and the company’s retained profits.
(1) The head of the table. The head of the table is the basic mark of the report, which lists the report’s name, the preparation unit, the number of the report, the date of preparation, and the amount unit. Since the balance sheet is a statement that reflects the static funds at the end of the period, the date of the report should be the date of the last day of the end of the reporting period.
(2) The basic part. The basic part is the statement’s main body, and the balance sheet is divided into the left and right sides.
Assets listed on the left:
1) Current assets. Including monetary funds, transactional financial assets, notes receivable, accounts receivable, provision for bad debts, advance payments, other receivables, inventory, etc.;
2) Non-current assets. Including available-for-sale financial assets, held-to-maturity investments, fixed assets, intangible assets, etc.
The rights are listed on the right. Specifically include debt items:
1) Current liabilities. Including short-term loans, bills payable, accounts payable, advance receipts, other payables, employee compensation payable, taxes payable, etc.
2) Long-term liabilities. Including long-term loans, bonds payable, long-term payables, etc. Owner’s equity items include paid-in capital, capital reserves, surplus reserves, undistributed profits, and other items.