Businesses have always debated what belongs on an income statement vs. a balance sheet. However, people who do business should understand this thoroughly. Because they both reflect components of your firm’s profitability, it's possible to get these two critical documents mixed up unless you belong to an accounting background.
In this article, we'll look at the differences between the balance sheet and the income statement as well as why both of those are so necessary for businesses. We'll also discuss their key differences, importance and components.
What is Income Statement?
One of the firm's basic financial statements, the Income Statement, illustrates its gains and losses over extended periods. All revenues are added together and all expenditures from both operational and non-operating activities are subtracted to define profit or loss.
An income statement aids businesses in determining if they can profit by boosting sales, lowering expenditures, or both. It also indicates the effects of the company's plans at the start of a fiscal period. This report can be used by company owners to see if their plans have paid off. They may provide with greatest strategies to increase earnings based on their statement analysis.
The Net Income is determined mathematically as follows:
Net Income = (Revenue + Gains) – (Expenses + Losses)
Importance of the Income Statement
The importance of an income statement depends on the administrative regulations, multiple business objectives, and related operations. Let's have a look at a few of them -
Company owners and operators can use the Income Statement to constantly monitor the company's productivity and make wise decisions, as well as to identify and resolve business issues before they become significant and costly.
This statement outlines the firm's growth, and expenditures, including any additional bills, as well as any sections that are over or under their budget. Property rents, wages, and other overheads are included in the expenses.
Overview of the business:
This statement provides stakeholders with a high level of understanding regarding the organization they decided to invest in. This report can also be used by finance companies and organizations to determine whether a business is creditworthy or not.
Major Components of Income Statement
The major components of an income statement are listed below-
- Revenue or sales
- Cost of goods sold (COGS)
- Gross profit
- Advertising expenses
- Administrative expenses
- Earnings before tax (EBT)
- Net income
What is Balance Sheet?
A balance sheet is a statement that outlines corporate resources, debts, and stockholders' capital at a particular timeframe (as indicated at the top of the statement). This is one of the primary sources that comprise a company's finances.
In a balance sheet, the total assets should be equal to the total liabilities and equity accounts on the balance sheet, which is:
A balance sheet shows the financial situation of a business or organization at a specific time, which is commonly prepared quarterly, half-yearly, or yearly. The Assets and Liabilities sections of the Balance Sheet are the most significant element.
Importance of the Balance Sheet
It is substantial since it aids in interpreting an organization's business. The following are some of the factors why it is essential:
- To determine a firm’s financial position.
- Shareholders can examine the balance sheet to learn about the firm's solvency and expected profits
- The progress of a corporation can be assessed by examining balance sheets across time.
- It is a requirement for obtaining a loan from a bank.
- The potential of a corporation to undertake growth initiatives and unexpected expenses can be determined by examining its balance sheets.
- It assists in determining the sources of a firm's finance, such as stock or debt financing.
Components of a Balance Sheet
The data points that show up on a balance sheet will differ slightly depending on the type of organization or industry. Because they all interact with almost the same kinds of operations, the data points utilized in the balance sheets of firms in the same sector are usually comparable. In most balance sheets, the major components found are-
- Cash and cash equivalents
- Marketable securities
- Prepaid expenses
- Accounts receivable
- Fixed assets
- Accounts payable
- Accrued liabilities
- Customer prepayments
- Taxes payable
- Short-term debt
- Long-term debt
- Additional paid-in capital
- Retained earnings
- Treasury stock
Financial information comes in various formats, but the balance sheet and income statement are frequently regarded as the most significant. These two statements function with each other to show how well your company performs, how much it's valued, and where improvements may be made. The key differences between the Balance Sheet and Income Statement are listed below-
The balance sheet indicates what a corporation owns in terms of assets and what it owes in terms of liabilities for a certain period.
On the other hand, an income statement displays the change in a company's revenue and expenses over time.
The balance sheet includes assets, liabilities, and equities etc. while the income statement displays income and expenses.
A balance sheet indicates what a company owns and owes, but an income statement demonstrates the company's performance.
The numerous column headings on the balance sheet are linked to each other. These characterize a company's financial situation, whereas the subtotals on the income statement are linked to revenues to assess net sales, operational profit rates, and net earnings.
A corporation would use the balance sheet to examine whether it has the capacity to meet all of its payment responsibilities, whereas, the income statement is often used to establish whether a company is making a profit and what changes may be necessary.
The importance of balance sheets and income statements varies from user to user. But overall, the balance sheet is considered secondary to the income statement in terms of importance because the income statement indicates the company's current situation (profit or loss).
Because a firm's resources could be used as leverage, lending companies and investors are normally more focused on the balance sheet rather than the income statement.
A balance sheet indicates a company's total assets and total liabilities and equity. The total assets of a business should be equal to its total liabilities and equity.
Hk Limited sells recreational items and takes out a 10-year, $10,000 loan from a financial institution. For that, the liabilities and assets both grow by $10,000. If the firm receives $5,000 from investments, its resources and stockholders' equity will both rise by $5,000.
Asset = Liabilities + equity
= $10,000 + $5000
$15,000 (Liabilities + Equity) = $15,000 (Assets)
On the other hand, it gained $25,000 from the sales of recreational items. It had total expenses of $15,000 on everyday functions required to run the firm.
Its income statement for the latest period shows that the net income is-
Net Income = Revenue – Expenses
= $25,000 – $15,000
The income statement in the sample above is the most basic type that any firm creates.
Let’s take a look at the comparison table below so that the details and differences can be pinpointed precisely-
Basis of Comparison
Defines the financial position of an organization at a specific time.
Provides an overview of the financial performance over a given period.
A balance sheet is more important for investors and creditors.
Overall, an Income Statement is more important for business owners.
Assets, liabilities and shareholder’s equity.
Income and expenses.
To determine the ability to meet financial commitments.
To determine if the company is making a profit or loss.
Creditors are more focused on the balance sheet.
Creditors are less focused on Income statements.
Defines a company's financial position.
Related to revenues to evaluate the net sales, operating profit rate, and net earnings.