Financial health is the lifeblood of any business. There are some obvious indicators of success — good sales, manageable expenses and a growing customer base, for example. But it’s important to get as accurate a picture as you can. And sometimes it’s hard to know where to begin.
That’s where two financial statements can help: balance sheets and income statements.
A balance sheet and an income statement are two different methods of gauging a business’s financial health. They’re similar, but not the same — and both are important. In this article, we’ll define a balance sheet and income statement, explain what goes on each document, and review their differences.
Balance Sheet vs. Income Statement
The difference between a balance sheet and an income statement is the information they show and the period of time they cover.
A balance sheet shows a company’s assets, liabilities and equity at a specific point in time. An income statement shows a company’s revenue, expenses, gains and losses over a longer period of time. Along with a cash flow statement, all three financial statements work together to paint a picture of a company’s financial position.
These documents are considered essential for understanding a business’s financial health.
What Is a Balance Sheet?
A balance sheet is a document that illustrates a business’s assets, liabilities and owner’s equity during a specific point in time.
Creditors and investors look at a company’s balance sheet to understand what the company owns (assets) and owes (liabilities). The balance between those two items communicates the company’s financial health.
It’s advised to update your balance sheet every month. This way, analysts will get the most accurate snapshot of your company’s financial position.
What Goes on a Balance Sheet?
A balance sheet is based on this simple equation:
Liabilities + Equity = Assets
Unless there’s some mistake, your company’s total assets should equal its total liabilities plus equity. This is where the balance sheet gets its name — the equation is “balanced.”
On your balance sheet should be two columns: assets on one side, liabilities and equity on the other.
Not sure what fits in these categories? Here’s a breakdown of what counts as assets, liabilities and equity.
Assets. These include cash, accounts receivable, inventory and property. In simpler terms, what your company owns. Keep in mind these include intangible assets like patents or intellectual property. Assets are usually listed in order of their liquidity — how quickly they can be converted to cash.
Cash, accounts receivable and inventory are listed under current assets on a balance sheet. Property (which includes intellectual property) is listed under non-current assets.
Liabilities. These consist of loans, debt and accounts payable — what your company owes. Underfunded pension plans, such as company-sponsored retirement plans, are also included as liabilities. Deferred tax liability — accumulated taxes that have not yet been paid — also goes in this category.
Accounts payable are listed under current liabilities. Underfunded pension plans and deferred tax liability are listed under non-current liabilities. Debt can be listed as either current or non-current depending on if the debt is short-term or long-term. However, upcoming repayments on long-term debt are listed as current.
Equity. Equity is made up of assets attributed to the owners or shareholders upon the company’s liquidation, after all liabilities are paid. Shareholders’ equity also includes retained earnings.
Included in this part of the balance sheet is a return of equity (ROE). To calculate the return of equity ratio, divide net income by shareholder equity.
Balance Sheet Example
A company’s balance sheet depends on its unique mix of assets, liabilities and equity. However, a balance sheet will typically follow the same format with an itemized list provided for a specific point in time.
(Date and Year)
Accounts receivable: $X,XXX
Total assets: $XX,XXX
Accounts payable: $X,XXX
Accrued wages: $X,XXX
Term debt: $XX,XXX
Total liabilities: $XX,XXX
Shareholder equity: $XX,XXX
Total equity: $XX,XXX
What Is an Income Statement?
An income statement is a document that illustrates a company’s financial performance over a specific period of time — usually a fiscal quarter or year. An income statement is also called a profit and loss statement.
The income statement provides information about a company’s sales revenue, expenses, gains and losses. This information is important to investors and lenders. It indicates if the company was profitable during the given time.
What Goes on an Income Statement?
The income statement includes revenue, expenses, gains and losses, and the resulting net income or loss.
An income statement does not include anything to do with cash flow, cash or non-cash sales.
Revenue. Revenue is the total income during the accounting period. It’s split into two categories: operating revenue and non-operating revenue. Operating revenue is a company’s revenue generated from main business activities, such as sales. Non-operating revenue is a company’s revenue generated from non-core business activities, such as rent or interest.
Realized gains and losses. Also included on an income statement are realized gains and losses, also known as “other income.” These are one-time gains generated from the disposal of a company’s assets, such as the sale of property.
Operating expenses. Operating expenses are regular, recurring expenses. Examples include the cost of goods sold (COGS), rent and payroll. Another type of expense is the depreciation of assets.
Net income/loss. At the end of an income statement is the net income or loss for the specified accounting period, also known as the bottom line.
To calculate net income (or loss), add realized gains and subtract expenses and realized losses.
(Revenue + Gains) – (Expenses + Losses) = Net Income
Income Statement Example
Every company’s income statement will look a little different based on their specific sources of revenue, expenses, gains and losses. This simple example should give you an idea of what to include on an income statement.
For the quarter ending (Date and Year)
Merchandise Sale: $XX,XXX
Revenue from Training: $X,XXX
Total Revenue: $XX,XXX
Interest Paid: $XX,XXX
Total Expenses: $XX,XXX
Income from sale of refrigerator: $X,XXX
Water damage: $X,XXX
What Are the Differences Between a Balance Sheet and an Income Statement?
Some key differences between a balance sheet and an income statement are what’s included, time frame, purpose and use.
What’s included. A balance sheet includes assets, liabilities and equity. An income statement includes revenue, expenses, gains and losses.
Time frame. A balance sheet shows information for a specific point in time. An income statement shows information over a period of time.
Purpose. A balance sheet measures financial health. An income statement measures financial performance.
A balance sheet allows analysts to calculate financial health ratios. These include current ratio, debt-to-equity ratio and return on equity (ROE). An income statement allows analysts to calculate performance-based ratios. These include gross margins, operating margins, price-to-earnings and interest coverage.
Use. A balance sheet is used by lenders to determine a company’s creditworthiness. It’s also used to determine if a company has assets that can be used as collateral.
An income statement is used by investors, management and others to examine a company’s current and future profitability. It’s also used to determine if a business makes enough profit to pay off short-term and long-term liabilities.