Balance Sheet vs. Income Statement: What’s the Difference?
Tracking the movement of money in and out of a business is a necessity and there are a number of tools that can make the process easier. Balance sheets and income statements are both used to capture a financial snapshot of a business at a given point in time. While these financial statements can provide insights into a business’ performance, there are some differences between the two.
What is a balance sheet?
A balance sheet is an assessment of a company’s financial health, as measured by its total assets, total liabilities, and owners’ equity. In simpler terms, a balance sheet explains what a business owns, what it owes, and its resulting net or “book” value.
Keeping a balance sheet is an important small business accounting practice that can yield valuable information about a company. The data on a balance sheet can serve multiple purposes.
For example, a business owner may analyze a balance sheet to gain a better understanding of the size of a company’s debt, relative to assets. If a company is carrying too much debt, the owner may try to reduce debt, so the numbers are more balanced.
Investors can also use balance sheets to evaluate things, like liquidity and solvency, when deciding whether to invest in a particular company. Putting together a strong balance sheet can help businesses that are looking to attract new shareholders or angel investors.
What is an income statement?
An income statement, also known as a profit and loss statement, keeps track of a business’ profits and losses.
Income statements organize financial information about a business into four areas:
- Revenue: The revenue section of an income statement includes money that comes in from operations, such as sales from products or services, and non-operational activities, such as royalty payments or investment income.
- Expenses: This line item refers to expenses incurred to maintain operations. These items include things like rent and utilities, transportation costs, and wages paid to employees.
- Gains: A gain represents money that flows into a business from activities other than those listed under the revenue section. For instance, if a business were to sell property for a profit, it would be considered a gain.
- Losses: Losses represent outflows from the business that are not expenses. A business would list a property sale as a loss if it were sold for less than the purchase price.
Once the numbers are in place, a business can calculate its net income using this formula: (Revenue + gains) – (Expenses + losses) = Net income
Net income is simply the amount of money a business makes after deducting all of its expenses and losses. Understanding net income matters, as it can show how much money a business has on hand at a specific point in time.
What are the main differences between a balance sheet and income statement?
Both an income statement and a balance sheet are useful in understanding a business’ performance and where it needs to adjust. The use of a balance sheet vs. an income statement depends on the types of insights being sought. Here are four factors to consider:
Time period
Balance sheets measure a company’s liquidity on a given day, referred to as the balance sheet date. For example, a company may use a balance sheet date of Dec. 31 if it is reporting assets, liabilities, and equity at the end of the calendar year. Companies can also use a balance sheet date that reflects the end of the fiscal year.
Income statements track gains and losses over a period of time. A company may publish income statements monthly or quarterly to gauge whether the numbers are trending up or down. Similar to a balance sheet, an income statement will specify the date range used for the reporting period.
What is reported
A balance sheet and income statement show a business’ financial health in different ways. That’s because each financial statement incorporates a different range of metrics and numbers.
Balance sheets break down the company’s assets, liabilities, and shareholder equity. They allow a business to measure its value at a glance. Income statements, meanwhile, report net revenues and expenses. The focus is on how much net income the business generates, vs. what it’s worth.
How they are used
Businesses use balance sheets to measure value, liquidity, and solvency. Measuring liquidity is important as it can show whether a business can meet its financial obligations. A significant amount of debt on a balance sheet could pose a threat to a business’ ability to pay its creditors and cover operating expenses.
Income statements are useful for tracking profitability over time. In other words, they tell business owners how much money they’re actually making. That can be helpful when weighing decisions like cutting expenses or raising prices to improve profit margins.
Business credit approval
The ability to access credit when needed matters to a business. If an enterprise needs working capital for day-to-day expenses or to fund a large-scale growth project, the balance sheet and income statements can affect its ability to qualify for a business loan or line of credit.
Lenders weigh the five Cs of credit – character, capacity, capital, collateral, and conditions – when deciding whether to approve business owners for loans. Lenders may look at a balance sheet to analyze the level of debt and number of assets. An income statement can shed light on how much a business spends each month compared to what it’s taking in.
Those kinds of details matter, as they speak to the capacity to repay obligations, the ability to provide collateral for secured loans, and the amount of available capital. The stronger the balance sheet and income statement, the easier it may be to get approved for a loan or business line of credit.
The relationship between an income statement and balance sheet
Income statements and balance sheets can help measure liquidity and value while tracking net income, but they can also serve a larger purpose.
Both types of financial statements can prove instrumental for developing realistic business objectives, tracking progress, and hitting key metrics for success. They can also help provide a better sense of what might be needed to hit certain benchmarks and whether a loan or business line of credit might help reach them.