Balance Sheet vs Income Statement: What’s The Difference?
The balance sheet and income statement are two of the most important financial statements every business tracks. The third important financial statement is the cash flow statement.
Business owners, investors, creditors, and auditors use these documents to analyze and draw out conclusions about the financial health of a business.
Usually, when a company has a healthy income statement, the balance sheet will also be healthy. However, one of these statements can be strong while the other is weak.
Balance sheets and income statements are both financial statements that provide information about the company’s finances, but they are not the same. They use different variables.
In this article, you will learn all the differences that exist between the balance sheet and income statement, including what makes them so important.
Let’s get started.
What Is a Balance Sheet?
A balance sheet is a financial statement that highlights what the company owes and owns at a specific time. It is one of the three essential financial statements or documents for analyzing a company’s financial performance. The other two financial statements are the income statement and cash flow statement.
According to Investopedia, “A balance sheet is a financial statement that reports a company's assets, liabilities and shareholders' equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure.”
The balance sheet shows what your business owns (assets), what it owes (liabilities), and what money is left over for the owners (owner’s equity). It is the relationship between your company’s assets, liabilities, and equity. Another name used for balance sheets is the statement of financial position.
Companies prepare their balance sheet at the end of an accounting period. For some companies, it can be monthly, for some quarterly, and others annually.
The Purpose of the Balance Sheet
The core purpose of a balance sheet is to provide a summary of or insight into your company’s financial position to investors, creditors, and other interested parties at any given time. Investors and creditors analyze the balance sheet to check the business’s overall financial health.
The balance sheet reveals how well the company’s management team is putting the business resources to good use.
Apart from investors and creditors, the company’s internal management team also uses the balance sheet to make decisions and track the business’s financial performance and health. Since the balance sheet shows all transactions the company made from its launch, it is one of the best indicators for monitoring its financial health.
With a balance sheet in hand, you can find information about how much money the business has spent, and how much debt the company owes. Investors and business owners can use it to compare the current assets to current liabilities to gauge the company’s ability to meet its financial obligations.
You can calculate several key financial ratios such as the debt to equity ratio and the current ratio with information from your company’s balance sheet. The debt to equity ratio shows the company’s ability to pay off its debt with its equity if the need emerges. On the other hand, the current ratio shows the company’s ability to pay off its debts within a year.
The Structure of the Balance Sheet
All balance sheets have three main divisions: assets, liabilities, and owner’s equity.
Assets are items that the company owns that can be converted into cash, sold, or consumed. On the balance sheet, assets are arraigned based on how easy it is to convert them into cash. There are two main classifications of assets: current assets and noncurrent assets.
They are assets that you can easily convert into cash within a year. These assets get listed first on the balance sheet before any other classification.
Current assets include:
- Money in a checking account.
- Money in transit refers to money transferred from another account.
- Inventory refers to the goods that a company has available for sale, which have a value lower than the marketplace. Inventory management is key in recording and preserving these assets. You can use inventory management software to efficiently track your company’s inventory.
- Accounts receivable refers to the money that the company is owned, usually by customers.
- Short-term investments refer to investments that a company expects to mature within a year.
- Prepaid expenses refer to the value of what the company has paid for such as rent, insurance, and advertising contracts.
- Cash equivalents are liquid assets, they include treasury bills, currency, stocks, short-term certificates of deposit, and bonds.
- Marketable securities are debt securities and equities that have a liquid asset.
They are assets that the company does not plan to convert into cash within a year. These assets fall under the current assets. Another name for non-current assets is long-term assets.
Non-current assets include:
- Fixed assets such as land, machinery, building, equipment, and other capital-intensive assets.
- Intangible assets refer to those non-physical assets that have value such as patents, trademarks, and goodwill. They only enter the balance sheet when they are acquired externally and not done in-house.
- Long-term investments refer to those securities that cannot be liquidated within a year.
Liabilities refer to money that a company owes external parties. They refer to a company’s financial obligations or debts such as taxes, wages, accounts payable, utilities, loans, and others. The difference between liabilities and expenses is that liability factor in future money owed.
There are two classifications of liabilities: current liabilities and non-current liabilities.
They are those liabilities that are due for payment within a year. On the balance sheet, liabilities get listed in order of their due date, with the earliest due date first before the others.
Examples of current liabilities include:
- Accounts payable (AP) refers to money a company owes to suppliers for items or services purchased.
- Current debt/notes payable are non-accounts payable obligations that are due within a year.
- Current portion of long-term debt refers to the portion of a company’s debt that a company has to service every year till its maturity date.
- Loans that mature within a year.
- Customer prepayments
- Bank indebtedness
- Dividends payable
- Interest payable
- Wages payable
- Earned and unearned premiums
- Taxes owed
They are those liabilities that are due after a year. Examples of long-term liabilities include:
- Loans that your business acquires which it does not have to pay back within a year.
- Interests and principal on bonds issued.
- Pension fund liability refers to money that a company is obligated to pay into its employees’ retirement accounts.
- Deferred tax liability refers to taxes a company owes but not due until the next year.
Equity refers to money that belongs to the business owners. For sole proprietorships, it is called owner’s equity and for corporations, it is called shareholders’ equity.
Examples of equity include:
- Share capital refers to the value of money that business owners or stakeholders invest in the company.
- Private or public stock.
Retained earnings refer to the profit that a company decides to keep and not share as dividends among shareholders.
The Balance Sheet Equation
The balance sheet equation refers to the sum of equity and liabilities which equals assets.
Assets = Liabilities + Equity
For example, if a company takes $5,000 from a commercial bank, its liabilities will increase but so will its assets.
$5,000 (Assets) = $5,000 (Liabilities) + Equity
If the same company takes $7,000 from shareholders, its equity will increase and so also will its assets.
$12,000 (Assets) = $5,000 (Liabilities) + $7,000 (Equity)
Your company’s total assets must always be equal to the sum of total liabilities and total equity or else your balance sheet is not balanced.
What is an Income Statement?
An income statement is a type of financial statement that shows the company’s income and expenditure. It reveals how much money the company makes, and how much money it spends over a period.
Other names for income statements are the profit and loss statement, statement of earnings, statement of operations, or statement of income.
Business owners, investors, creditors, and accountants use the income statement to gauge the company’s financial health. This financial statement can indicate whether a company is making a profit or a loss for the set period. It also provides information about the ability and efficiency of the company’s management team.
The income statement contains valuable information about the company’s sales, revenue, and expenses. Companies use their income statement to make essential financial decisions.
With the aid of income statements, companies can closely monitor their revenue and expenses and prevent their costs from rising above their revenue. If a company's expenses grow faster than its revenue, the company could lose its profit gains.
Components of an Income Statement
The components of an income statement may differ from one company to another depending on the regulatory requirements and the type of operations or business conducted. A regular income statement consists of the following components.
Revenue or Sales
Revenue or sales refers to what the company makes from sales and other services rendered to its customers. Every income statement has sales or revenue as its first section. This section shows the gross sales that a company makes in a given period.
Sales or revenue on the income statement falls under two classifications: operating and non-operating.
Operating revenue refers to the revenue that a company gains from performing its primary activities. The primary activities of a retailer are purchasing and selling products, while that of a manufacturer is producing and selling products.
For a company that provides services, its primary activity involves the acquisition of expertise in an area and selling it to its clients.
The revenue generated by retailers, manufacturers, wholesalers, and distributors from their primary activities is called sales revenue. On the other hand, the revenue generated by service providers or companies from their primary activities is called service revenues or fees earned.
Non-operating revenue refers to revenues a company generates from its secondary activities. It refers to the revenue gotten by performing non-core business activities such as system maintenance, installation, and others.
Any revenue that a company or business generates outside its core or primary activities of purchasing and selling goods and services falls under non-operating revenue. For example, when a company keeps funds in a savings account and earns interest on it, or when it leases out some of its office space to other businesses.
The non-operating revenue gets reported on the income statement in a different section from the operating revenue. Both the operating revenue and non-operating revenue are reported on the income statement when they are earned, as opposed to when the company receives the cash.
Cost of Goods Sold (COGS)
COGS refers to the total costs incurred to manufacture goods, make sales, or render services. Only the cost of goods that you sell falls under COGS. Other indirect costs like overhead are not a factor in calculating the costs of goods sold.
Gross profit is what is left when you subtract the cost of goods sold from the sales revenue. Mathematically, it is portrayed as net sales minus the cost of goods sold.
Net Sales – Cost of Goods Sold (COGS) = Gross Profit
Net Sales here refer to the total amount of money your business receives from the sale of goods, while the cost of goods sold refers to the total expenses incurred to produce those goods.
Gains refers to the positive situations or events that cause a company’s income to increase. It refers to the money a company or business realizes from non-business activities.
Profits a business or company gets from selling off some of its assets such as vehicles or lands fall under its gains. Gain is typically classified as secondary revenue. It usually involves the sale of fixed assets.
Expenses refer to the cost that a company incurs to run its operating activities and generate revenue. Some examples of expenses include employee wages and salaries, equipment depreciation, payments to suppliers, and others.
There are two main categories of expenses for businesses, they are operating and non-operating expenses.
All expenses generated from the company’s core business activities to earn operating revenue are operating expenses. They are the expenses generated from the company’s primary activities. Examples of operating expenses include payroll, pension contributions, and sales commissions.
All expenses generated from the company’s secondary activities or non-core business activities fall under non-operating expenses. Examples of non-operating expenses include lawsuit settlement or obsolete inventory charge.
Advertising expenses refer to the total costs spent on marketing your company or its products to draw more sales and expand its client base. There are several advertising mediums businesses use for advertisement needs. They include print media and online media such as social media ads.
This type of expense generally falls under the Sales, General & Administrative (SG&A) expenses.
Administrative expenses refer to the general expenses a company incurs which is not associated with the expenses of a specific department. Examples of administrative expenses include travel expenses, salaries, wages rent, and office supplies.
Earnings Before Tax (EBT)
Earnings before tax (EBT) refers to how profitable your business or company is before it pays taxes to the government. It is a good indicator for measuring a company’s financial performance.
The formula for calculating EBT is simple, subtract total expenses from total income before tax is paid. On a multi-step income statement, you will find EBT as one of its line items.
Income Tax Expense
Income tax expense refers to the total tax a company pays to the Internal Revenue Service (IRS) or the appropriate tax collecting body on its income.
Net profit is the value left after deducting allowable business expenses from total revenue. It is the final profit for your company.
Income Statement/Net Income Formula
The formula for net income is:
Net Income = (Revenue + Gains) – (Expenses + Losses)
This formula is the simplest form of the income statement that any business can generate. It is called the Single-Step Income Statement.
Large companies because of their involvement in a global market, acquisitions, mergers, and other business activities require more complex accounting needs than what this formula offers.
Balance Sheet vs Income Statement: The Key Differences
The balance sheet and the income statement are two financial statements which when combined provides a full account of a company’s financial health and prospects.
Investors, creditors, and even the company’s internal management team use these financial statements to make important business decisions.
The balance sheet and income statement are two different financial documents. It is important to note the key differences between these two financial statements to help you efficiently gauge the health of your company.
There are several key differences between the balance sheet and income statement, starting with their definition.
A balance sheet is a financial statement that highlights what the company owes and owns at a specific time. On the other hand, an income statement is a type of financial statement that shows the company’s income and expenditure.
Other keys and noteworthy differences between these two financial statements include:
One of the key differences between the balance sheet and the income statement is timing. The balance sheet shows the company assets and liabilities (what it owns and what it owes) at a specific period. On the other hand, the income statement shows the company’s total income and expenditure over some time.
For example, when a company releases its financial statements for June, it will contain a balance sheet as of June 30, and an income statement for June.
The income statement shows the performance of the company over a period, while the balance sheet does not indicate performance.
Both financial statements report different aspects of the company’s finances. The balance sheet produces reports on the company’s assets, liabilities, and equity. On the other hand, the income statement produces reports on the company’s revenue and expenses, including whether the company made a profit or loss.
Companies use the balance sheet and income statement for different reasons. The balance sheet helps a company determine if it has enough assets to meet its financial goals. On the other hand, the income statements evaluate the performance of a company to find any financial situation that needs adjusting.
The company’s management team uses both the balance sheet and the income statement to gauge its financial health. Companies’ management teams use the balance sheet to gauge if the company has enough liquid assets to meet its pressing financial obligations. They use the income statement to check the results of the company’s financial results.
Creditors and lenders also use both the balance sheet and income sheet, albeit for different reasons. They use the balance sheet to check if the company has an over-leveraged financial position.
The income statement helps creditors and lenders determine if a company is generating enough profit to handle its liabilities.
Lenders check the balance sheet before it provides credit services or extends more services to a company. They use the income statement to check if the company is making enough profit to meet up its financial obligations (pay its liabilities).
6. Different Calculations
The income statements add up all of the company’s revenue and expenses, and then deduct the expenses from the revenue to determine if the company made a profit or loss.
On the other hand, the balance sheet involves several calculations. To calculate the company’s assets, you add the company’s liabilities and its equity. The asset must at all points be equal to the sum of the company’s liabilities and its equity on the balance sheet.
To calculate the owner’s equity, you have to subtract the company’s liabilities from its assets. Also, if you want to calculate the liabilities, you have to subtract the company’s equity from its assets.
Together, These Financial Statements Show How Your Business is Doing
The balance sheet and income statement are two of the three most essential financial statements that gauge a company’s financial health. The third is the cash flow statement. Together, these financial statements reveal how well a company or business is performing.
Although the balance sheet and income statement have their differences, they still have things in common. Creditors and investors use them to decide whether they want to be involved financially in a company or not.
The balance sheet and income statement may evaluate different financial information but together they provide insights into a company’s current and financial health. Companies’ internal management teams use these financial statements to set, adjust and refine their financial goals, OKRs, and KPIs.
Businesses can make use of accounting software to calculate these financial statements (balance sheet, income statement, and cash flow statement). There are also affordable small business accounting software that help to automate a company’s accounting process.