What are the key differences between a balance sheet vs. income statement? Learn more for better financial record-keeping.
Balance sheets and income statements are both financial statements that help you understand the financial health of an organization, but they have key differences. A balance sheet shows a company’s immediate financial position, whereas an income statement measures performance over a period of time. Board directors, especially within the finance committee, should be able to read and analyze both reports. Read on to learn more about a balance sheet vs. income statement.
What Is a Balance Sheet?
A balance sheet is a two-sided financial statement. The left side records an organization’s assets, while the right shows shareholders’ equity and business liabilities.
This financial statement provides an instant snapshot of a company’s financial standing in a specific accounting period. It shows the capital in a business, what a business owns, and what a business owes others.
Lenders and investors use the balance sheet to make an informed decision before financing a business. For example, by comparing the total debts to total assets, they get the debt ratio, which indicates a company’s financial position.
Components of a Balance Sheet
A balance sheet has three components: assets, shareholder’s equity (capital), and liabilities. These three elements comprise the balance sheet equation below.
Assets = Shareholders’ Equity + Liabilities
An asset is any resource an organization owns and can use to produce value. A business can sell an asset to get revenue. Alternatively, it can use an asset to provide services or make products that generate income. Assets include:
- Real estate
- Accounts receivable
- Business equipment
- Trademarks and patents
Liabilities are the amount of money a business owes to others. They include the following business debts:
- Outstanding rent
- Unpaid loans
- Money your company owes to suppliers
- Unpaid salaries
- Payable taxes
3. Shareholders’ Equity
Shareholders’ equity is the balance of assets left over after a business pays off all its liabilities. It’s the money that would go to owners of shareholders should the business liquidate. Shareholders’ equity is also called share capital.
Accurate balance sheet figures enable companies to determine their true financial position. Follow these tips for organizing and maintaining an accurate balance sheet.
- Double-check how you’ve classified transactions.
- Ensure you correctly categorize current and fixed assets. Do the same to short- and long-term liabilities.
- Record entries using a standard format for easy analysis.
A two-sided balance sheet format is common. You record balance sheet entries in order of liquidity on both sides: more liquid (current) items come first, then the illiquid (fixed or long-term) follow.
Current assets should come before fixed assets on the right side of the balance sheet. On the left side of the balance sheet, short-term liabilities should come before long-term assets.
What Is an Income Statement?
An income statement is a financial statement that shows how much revenue an organization earned over a specific accounting period. It also outlines the organization’s expenses and costs of generating revenue.
The income statement’s bottom-line figure represents a company’s net income or losses. In short, it shows what an organization earned or lost over a particular period.
An income statement is also called a profit and loss (P&L) statement. It helps the management team, including the board of directors, understand the organization’s net income to make informed decisions.
For example, board members may use a P&L statement to identify if the organization is making enough profit to justify renovating the organization’s building or expanding in other ways.
An income statement is also crucial when applying for loans or looking for funds from investors. Investors and lenders use income statement figures to compare a company’s net income against taxes, debts, and operating expenses. These details help them decide whether funding a company is worth it.
Components of an Income Statement
An income statement has five key components:
1. Total Revenue
The total revenue is the gross income from selling services or products.
2. Cost of Goods Sold (COGS)
Cost of goods sold is the total amount a business spent to buy or make the products it sells in a specific period. It’s also called cost of sales, and includes expenses for distributing goods.
3. Gross Profit
Gross profit is a company’s revenue before deducting operating costs. You get a company’s gross profit by subtracting the cost of goods sold from total revenue.
4. Operating Expenses
Operating expenses are costs of generating revenue. Here are examples of such costs:
- Administrative fees
- Marketing fees
- Utility costs (water and electricity bills)
- Employee salaries
5. Net Income or Loss
Net income or loss is the balance after deducting total expenses from gross profit. A positive figure means net income, while a negative figure means a loss.
Key Differences Between a Balance Sheet vs. Income Statement
The key differences between a balance sheet and income statement include:
Usage: Lenders and investors use a balance sheet to determine a company’s creditworthiness and the availability of assets for collateral. Shareholders, investors, and management use an income statement to evaluate business performance.
Components: The balance sheet records assets, shareholders’ equity, and liabilities. An income statement records gross revenue, operating expenses, COGS, gross profit, and net income.
Time: A balance sheet summarizes an organization’s financial health at a specific time. An income statement shows a company’s financial health for a specific period, usually quarterly or annually.
Store and Organize Documentation Using a Board Management Solution
Income statements and balance sheets are just two of the crucial documents a board must report and keep on file. For better bookkeeping and reporting, boards rely on OnBoard, a purpose-built board management platform that helps boards move smarter, work faster, and achieve more. Its limitless system of record is backed by enterprise-grade security to ensure sensitive company information remains protected.
About The Author
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