Income statement vs Balance SheetDifferences & Comparison

The balance sheet and the income statement.

These are two of the three main financial statements (the third being the statement of cash flows).

The balance sheet (a.k.a. the statement of financial position) is a financial statement that presents the balance of assets, liabilities, and equity of a business at a certain point in time.

On the other hand, the income statement presents the revenue, expenses, as well as net income of a business for a given period.

These two financial statements present their intended users with different bits of information.

But is one more important than the other?

Can a business afford to only prepare one of the two?

Is there a point in separating the information found in these two financial statements?

These are questions that we will answer in this article.

We will be taking a closer look at the balance sheet and income statement and see what differentiates them.

We’ll be reviewing what a balance sheet is, what information we can find in one.

Of course, we’ll be doing the same with the income statement.

By the end of the article, we should be able to identify the roles that these two financial statements have for a business.

Balance Sheet: What is it?

Another name for the balance sheet is “the statement of financial position”, which should give you an idea as to what information it presents.

Basically, a balance sheet shows us a business’s financial position at a certain point in time.

By that, I mean that it contains information about a business’s assets, liabilities, as well as equity.

The balance sheet follows the basic accounting equation which is “Assets = Liabilities + Equity”.

What this means is that a business’s assets are funded by liabilities (e.g. creditors, bondholders) and equity (investors, shareholders, owner/s).

Some balance sheets may contain more detailed information.

However, a basic balance sheet will provide you with just enough information to gauge a business’s financial standing.

It will show you the business’s total assets, how the business is financing them (debt, equity, or a mix of both).

It will show how well the business is faring regarding its financial position.

The details of the balance sheet accounts can then be found on a business’s notes to financial statements.

There are also supplemental reports such as the aging report that provides details of the age of each receivable.

A balance sheet will tell you how much cash the business has, how many capital assets it is holding, how much does it owe its creditors, etc.

Aside from that, analysts use the information found on a balance sheet to arrive at certain financial ratios.

For example, to compute a business’s current ratio, the analysts will need to know the business’s total current assets and total liabilities.

The current ratio measures a business’s ability to pay short-term debts (current liabilities) with just its current assets.

The Contents of a Balance Sheet

A typical balance sheet segregates its accounts into three major categories: assets, liabilities, and equity.

Let’s take a look at these three categories.

Assets

Assets are properties that the business owns and/or controls.

These properties typically provide the business with economic benefits.

For example, cash allows the business to purchase other assets.

Cash also allows a business to pay for its expenses and liabilities.

Capital or fixed assets such as buildings, machinery, and equipment facilitate the operations of the business, which will eventually lead to the generation of revenue (as well as profits).

Assets can be further segregated into two categories: current and noncurrent.

Current assets are those that a business can convert to cash within a short amount of time.

Or they could be assets that the business usually consumes within a year.

Examples of current assets are the following:

• Cash and Cash Equivalents
• Accounts Receivable
• Notes Receivable
• Inventory
• Prepaid Expenses

On the other hand, noncurrent assets are those that can provide the business with economic benefits for more than one year.

These are assets that the business uses for several years.

For example, a business can use a piece of machinery for five years.

Examples of noncurrent assets are the following:

• Land
• Building
• Machinery
• Equipment
• Patents
• Trademarks
• Copyright

Usually, a balance sheet will arrange its asset accounts according to liquidity, listing the most liquid asset first.

This is why you see cash as the first line item in most balance sheets.

Cash is the most liquid asset after all.

The only time you won’t see cash as the first line item is when the business doesn’t have any cash.

Liabilities

Liabilities represent the financial obligations of the business.

These are what the business owes to external parties such as creditors, or sometimes customers (in the case of unearned revenue).

In the event that the business liquidates, it will satisfy all of its liabilities first before the owners or equity holders receive any money or asset.

Same with assets, liabilities can be segregated into two categories: current and noncurrent.

Current liabilities are debts that the business needs to pay within a short amount of time, typically within a year.

These typically include liabilities resulting from operating costs.

Examples of current liabilities are the following:

• Accounts Payable
• Accrued Expenses
• Unearned Revenue
• The portion of Loans Payable that is due within a year

Noncurrent liabilities are debts that are only payable after a year or so.

These are typically long-term obligations.

They usually come with an obligation to pay for interest.

Examples of noncurrent liabilities are the following:

• Long-term Debt (e.g. loans with a term of more than a year)
• Pension Fund Liability
• Deferred Tax Liability

Liabilities are usually presented in a balance sheet where current liabilities are listed first before noncurrent liabilities.

Equity

Equity refers to the residual amount after subtracting a business’s liabilities from its assets.

It also represents the owner or owners’ stake in the business.

In a way, you can consider it as the amount the business owes to its owner/s.

Depending on how the business is structured, equity will be listed under a different account title.

In a sole proprietorship, it’s owner’s equity.

In a partnership, it’s partners’ equity with a separate capital account for each partner.

Lastly, in a corporation, it’s shareholder’s equity.

At the inception of the business, equity will only include the amount initially invested by the owner/s.

As the business continues to operate, it will either generate profits or losses.

Profits increase equity while losses decrease it.

Income Statement: What is it?

The income statement (a.k.a the statement of financial performance) is a financial statement that provides us with information regarding a business’s financial performance for a given period.

It shows how well the business did in terms of generating revenue and profits, as well as managing its costs and expenses.

A basic income statement will show you enough information to gauge a business’s profitability or operational efficiency for a given period.

However, if you want to skim over it just to know how much profit the business generated for the period, you can go straight to the bottom-line figure which is the business’s net income.

If the total revenue exceeds all expenses, the income statement will have net income as its bottom-line figure.

On the other hand, if expenses exceed total revenue, it will be net loss instead.

The information found on an income statement can be used for the calculation of certain financial ratios.

For example, to compute the gross profit ratio, you will need to know the business’s revenue and cost of sales figures.

The gross profit ratio measure how much gross profit a business makes for every dollar of revenue.

The main purpose of an income statement is to report information regarding a business’s ability to generate profit.

We can also derive from it how the business handles its costs and expenses.

Not only is it useful for internal users, but it’s valuable for external users as well.

The business’s management team can use it to review key performance indicators.

Creditors can use it to gauge whether it’s worth extending credit to the business.

Investors can use it to assess whether the business is generating enough profit to make it worth investing in.

The Contents of an Income Statement

A typical income statement will contain information regarding the business’s revenue, cost of sales, operating expenses, non-operating income and expenses, and net income (or net loss).

Revenue/Sales

Revenue represents the amount of revenue that the business was able to generate for a given period.

Revenue can either come from the sales of goods or the performance of services.

Some businesses only offer goods or services, while others offer both.

Whatever the case, revenue is the amount that the business generates from its normal business operations.

Depending on the accounting method that the business employs, revenue can be recorded at different instances.

Under the cash accounting method, the business records revenue whenever it receives cash from its customers.

Under the accrual accounting method, the business only records revenue when a sale is made, or when a service is completed.

The revenue/sales account is usually the first line item of an income statement.

As such, it is also known as the top line of an income statement.

All costs and expenses are deducted from it to arrive at the business’s net income.

Cost of Sales

Cost of sales refers to any expense that a business can directly attribute to the generation of revenue/sales.

For example, when you sell a product, the cost of the product is a cost of sales.

Deducting the cost of sales from the revenue will give us the business’s gross profit.

Depending on what the business offers, the costs of sales may take another name.

If the business solely offers goods, it’s the Cost of Goods Sold.

On the other hand, if the business solely offers services, it’s Service Cost or Cost of Services.  

Operating Expenses

Operating expenses refer to expenses that cannot be directly attributed to revenue, but they’re still necessary for the business to continue operating.

Examples include rent for the admin office, general and administrative expenses, the salaries and wages of sales and administrative staff, etc.

As long as the business continues its operations, it will incur operating expenses.

Non-operating Income and Expenses

Sometimes, a business may earn money outside of normal business operations.

For example, it may generate a gain on the sale of a fixed asset.

It could also go the other way around.

The business may incur expenses that aren’t necessarily operating expenses.

For example, the interest payments of loans.

These are included in the income statement as even though they aren’t from normal business operations, they still affect the bottom line.

Net Income

Net income is the bottom line figure of an income statement.

It is the figure that you’d arrive at after adding all revenue and non-operating income, then subtracting all costs and expenses (operating and non-operating, as well as taxes).

Essentially, it’s what the business truly earns after considering all costs and expenses.

A business will have net income if revenue (plus other income) exceeds all costs and expenses.

On the other hand, it will have a net loss if all costs and expenses exceed revenue.

Ideally, you want your business to generate net income, not a net loss.

The Balance Sheet VS The Income Statement

So after going through the contents of each financial statement, we finally have an idea of what differentiates them.

Firstly, the timing.

The balance sheet provides information about a business’s financial standing at a specific point in time.

On the other hand, the income statement provides information about a business’s financial performance for a given period.

This means that the balance sheet may contain information since the creation of the business.

Whereas, the income statement only contains information for the period concerned.

Notice that balance sheets report “as of December 31, XXXX”, while income statements report “for the period December 31, XXXX”?

That’s the difference in timing there.

Next, there’s the difference in items reported. The balance sheet reports assets, liabilities, and equity accounts.

Whereas, the income statement reports revenue and expense accounts, which are closed at the end of the period.

The balance sheet is useful in assessing the financial condition of the business.

On the other hand, the income statement is useful in assessing its financial performance.

Since they both provide different information, it’s not advisable for a business to only prepare one of the two.

Each has its role to fulfill.

Together, they provide a full picture of the business’s financial health.