Income Statement vs Balance Sheet with their Components and Importance

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.

>> Check out the Comparison Table

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 -

Frequent reports: 

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.

Identifying expenses: 

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
• Gains
• Expenses
• Advertising expenses
• Administrative expenses
• Depreciation
• 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 this sheet, the total assets should be equal to the total liabilities and equity accounts on the balance sheet, which is:

Assets = Liabilities + Equity

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 this 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 this 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 these sheets of firms in the same sector are usually comparable. In most balance sheets, the major components found are-

Assets - 

• Cash and cash equivalents
• Marketable securities
• Prepaid expenses
• Accounts receivable
• Inventory
• Fixed assets

Liabilities -

• Accounts payable
• Accrued liabilities
• Customer prepayments
• Taxes payable
• Short-term debt
• Long-term debt

Shareholders’ Equity-

• Stock
• Additional paid-in capital
• Retained earnings
• Treasury stock

Key Differences Between Income Statement and Balance Sheet

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-

Time

The BS 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.

Items Displayed

The balance sheet includes assets, liabilities, and equities etc. while the income statement displays income and expenses.

Overview

A balance sheet indicates what a company owns and owes, but an income statement demonstrates the company's performance. 

Metrics

The numerous column headings on the BS 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.

Usage

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.

Relative Importance

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). 

Creditors

Because a firm's resources could be used as leverage, lending companies and investors are normally more focused on the BS rather than the income statement.

Practical Example

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.

We know,

Asset = Liabilities + equity

          = $10,000 + $5000 

          = $15,000 

$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

                    = $10,000

The income statement in the sample above is the most basic type that any firm creates.

Income Statement vs. Balance Sheet Comparison Table

Let’s take a look at the comparison table below so that the details and differences can be pinpointed precisely-