We’ve covered the three primary financial statements that all businesses should be aware of and the information that they offer. Now we are going to expand upon these by looking at the relationship between them. In this particular article, we will look at the relationship between the Balance Sheet and the Income Statement, comparing and contrasting them, along with highlighting their importance.
As a reminder, the Balance Sheet provides an overview of the businesses’ assets, liabilities, and equity for a specific point in time. Assets are the businesses’ resources, each with a monetary value that is based on objective evidence. Liabilities and Equity divide those resources amongst those that belong to creditors or others (Liabilities) and those that belong to the business owners or shareholders (Equity).
The Balance Sheet acts as a more thoroughly explained representation of the Accounting Equation (Assets = Liabilities + Equity), allowing anyone who looks at it to see the net worth of your business and whether its financial position is more reliant on external creditors or the owners' investment. A financial analyst can use the data it provides to gain a more thorough insight into the business’ stability as well. One such tool is the Ratio of Liabilities to Owner’s Equity, which can be used to determine if the business would be in a better position to withstand harsher economic or market conditions that would affect it.
In contrast, the Income Statement (or Profit & Loss Statement) focuses primarily on the businesses’ revenues and expenses over a set time period. Revenue is the business’ earnings for providing services or selling goods, while expenses cover the money or assets lost in the process of running the business. If the business has earned more revenue than the collective expenses for that time period, it has gained net income. If it has lost more than it has gained, then it suffers a net loss.
The Income Statement narrows its focus onto the business’ methods of earning money and the cost of doing business, listing the different sources of income and expenses. While investors and lenders can find that information useful, it tends to be more crucial for internal users within the business because it allows them to determine what income streams are most profitable or what expenses are more costly, and then plan around how to improve them.
The difference start showing when you compare the data that the statements provide, along with who benefits the most from the knowledge. The Balance Sheet takes a snapshot of what the business owns and owes at any one point in time, but not how it reached that point or what can affect it. The Income Statement shows how well the business is performing over a set period of time, but doesn’t inform you if the business is capable of handling a shift in the economic condition or repaying what it owes.
And, with that, you have a basic understanding of the differences between the two statements. Both are essential for every business to have, so having them prepared should always be a priority. If you require a bookkeeping firm that will create these financial statements for you then don’t hesitate to Contact Us. We’ll help keep your books in the black.
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