Recently, we discussed Why Debt Payments and Owner’s Draws Don’t Show Up on a P&L, but Will be on the Balance Sheet. Since then, we’ve had a few questions on the major differences between the balance sheet and P&L statements. Therefore, we thought we’d dig in and talk about those differences. Each are used to provide ongoing records of a of a company’s financial condition but are looked at in different ways:
1. Treatment of Time
One main difference is the way they show the financial standing of a company at different points in time. The balance sheet summarizes the financial position of a company for one specific point in time. Perhaps at the end of a month or quarter. The P&L Statement (Income Statement), however, shows revenues and expenses during a set period of time. For instance, it will show what may have happened with all sales and expenses over the course of a month, quarter or year.
2. Focused on Different Financial Items
The balance sheet reports the assets, liabilities and shareholders’ equity during a specific period. It shows what a company owns and owes, as well as the amount that may be invested by shareholders.
The P&L statement shows net income, while the balance sheet will show how much a company is worth, or its total value. Balance sheets will also show how a company’s resources or assets are financed (whether it’s through debt, issuing equity to shareholders, etc.). Additionally, it will show how a company puts its assets to work and how those assets are financed. In the end, Shareholders’ Equity is the difference between the assets and liabilities. In other words, the money left over for shareholders if all debts have been repaid.
3. Purpose of Financial Reports
Each is built for a slightly different purpose. Balance sheets are built more broadly. It shows what a company owns and owes, as well as any long-term investments the company may have, essentially the full value of the long-term investments or debts appears on the balance sheet. The balance sheet provides those who are looking (creditors, investors, management, etc.) a snapshot as to how effectively the company’s management uses its resources.
The P&L statement, on the other hand, provides information about whether a company can generate a profit by either increasing revenue (sales), reducing expenses, or both. It answers an important business question: Is the company profitable? Management can review their own financial health and when income statements are closely monitored. It also helps to highlight where the strengths and weaknesses lie. The P&L statement is used more often by owners and management of a business. This is because of the need to constantly monitor operational efficiency and profitability. The IRS also focuses on income statements to determine the amount of tax a business owes.
4. How They Are Calculated
The income statement will require the preparer to add up the company’s revenue on one portion, while adding up all the expenses in another portion. The total expenses will then be subtracted from the total revenue, which will result in a profit or loss.
The balance sheet, however, has different calculations that are all performed under one basic formula: Assets = Liabilities + Owners Equity.
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