A balance sheet is a financial statement that provides a snapshot of a company’s financial position at a specific time. It presents a summary of what a company owns (assets), what it owes (liabilities), and the shareholders’ equity (the company’s net worth). The balance sheet follows the fundamental accounting equation:  

Assets = Liabilities + Shareholders’ Equity  

What are the components of the balance sheet?   

The components of a balance sheet include:  

1. Assets

Assets represent what a company owns or controls and can be classified into two categories:  

– Current Assets

These assets are expected to be converted into cash or used up within one year. Examples include cash and cash equivalents, accounts receivable (money owed to the company by customers), inventory, and short-term investments.  

– Non-current Assets

Also known as long-term assets, these are assets with more than one year of useful life. They include property, plant, equipment (PP&E), intangible assets (such as patents and trademarks), long-term investments, and deferred tax assets.  

2. Liabilities

Liability represents the company’s obligations or debts to external parties. Like assets, liabilities are categorized into two main types:  

– Current Liabilities

These obligations are expected to be settled within one year. They include accounts payable (money the company owes suppliers), short-term loans, accrued expenses, and current portions of long-term debt.  

– Non-current Liabilities

Also known as long-term liabilities, these are obligations with a due date beyond one year. Examples include long-term loans, bonds payable, deferred tax, and pension liabilities.  

3. Shareholders’ Equity

Shareholders’ equity, also called owners’ equity or stockholders’ equity, represents the residual interest in the company’s assets after deducting liabilities. It includes:  

– Share Capital

The funds the company raises by issuing shares.  

– Retained Earnings

The accumulated profits or losses the company has retained over time.  

– Additional Paid-in Capital

The amount received from shareholders over the par value of the shares issued.  

– Treasury Stock

The company’s shares that it has repurchased and is holding.  

– Other Comprehensive Income

Gains or losses not included in the net income but affect shareholders’ equity, such as unrealized gains or losses on investments.  

The balance sheet provides important information about a company’s financial health, liquidity, solvency, and the composition of its capital structure. It is typically prepared at the end of an accounting period, such as a month, quarter, or fiscal year.  

What is an income statement? What are the components of the income statement?  

An income statement, also known as a profit and loss statement or statement of earnings, is a financial statement that summarizes the revenues, expenses, and resulting net income or net loss of a company for a specific period. It provides information about a company’s financial performance over a given period, typically quarterly or annually.  

The income statement follows a specific format and consists of several components, which include:  

1. Revenue

The total money earned from the company’s primary business activities. It includes sales revenue, service fees, rental income, and any other sources of income directly related to the company’s operations.  

2. Cost of Goods Sold (COGS) or Cost of Sales

This refers to the direct costs incurred in producing or acquiring the goods or services sold by the company. It includes expenses such as raw materials, direct labor, and manufacturing overhead.  

3. Gross Profit

Gross profit is calculated by subtracting the cost of goods sold from the total revenue. It represents the profit generated by the company’s core operations before considering other operating expenses.  

4. Operating Expenses

These are expenses incurred by the company in its day-to-day operations. They include selling expenses (such as marketing and advertising costs), general and administrative expenses (such as salaries, rent, and utilities), research and development expenses, and any other costs directly related to running the business.  

5. Operating Income or Operating Profit

Operating income is calculated by subtracting operating expenses from gross profit. It represents the profit generated from the company’s core operations before considering non-operating expenses and income taxes.  

6. Non-operating Income and Expenses

These are revenues and expenses that are not directly related to the company’s core operations. Non-operating income may include interest income, dividend income, or gains from the sale of assets. Non-operating expenses may include interest expenses or losses from the sale of assets.  

7. Income Before Taxes

This is calculated by adding non-operating income and subtracting non-operating expenses from operating income. It represents the company’s profit before income taxes are deducted.  

8. Income Taxes

This component represents the company’s income tax expense based on applicable tax laws and regulations.  

9. Net Income or Net Loss

Net income is calculated by subtracting income taxes from income before taxes. After accounting for all expenses and taxes, it represents the company’s overall profit or loss.  

The income statement helps investors, analysts, and other stakeholders assess a company’s profitability, financial health, and operational efficiency. It is essential to a company’s financial statements, balance sheets, and cash flow statements.  

What are the differences between a balance sheet and an income statement?  

A balance sheet and an income statement are two financial statements used to assess a company’s financial position and performance. Still, they serve different purposes and provide different types of information. Here are the key differences between the two:  

1. Purpose

  – Balance Sheet

A balance sheet provides a snapshot of a company’s financial position at a specific point in time. It shows the company’s assets, liabilities, and shareholders’ equity.  

  – Income Statement

An income statement, also known as a profit and loss statement, summarizes a company’s revenues, expenses, gains, and losses over a specific period, typically a month, quarter, or year. It shows the company’s financial performance during that period.  

2. Period

  – Balance Sheet

It represents a company’s financial position at a specific date, typically the end of a reporting period.  

  – Income Statement

It covers a specific period, such as a month, quarter, or year. It shows the financial results and performance during that period.  

3. Information Presented

  – Balance Sheet

It provides information about a company’s assets (what it owns), liabilities (what it owes), and shareholders’ equity (the difference between assets and liabilities). The balance sheet follows the fundamental accounting equation: Assets = Liabilities + Shareholders’ Equity.  

  – Income Statement

It presents information about a company’s revenues, expenses, gains, and losses. It shows the company’s net income or net loss, which is the difference between revenues and expenses. The income statement follows the equation: Revenues – Expenses = Net Income (or Net Loss).  

4. Focus

  – Balance Sheet

It emphasizes the company’s financial position and the resources it controls. It provides insights into the company’s liquidity, solvency, and capital structure.  

  – Income Statement

It focuses on the company’s financial performance and how it generates profits or incurs losses. It highlights the company’s ability to generate revenue, manage expenses, and determine profitability.  

5. Presentation Format

  – Balance Sheet

It presents information vertically, with assets listed first, followed by liabilities and shareholders’ equity.  

  – Income Statement

It presents information in a horizontal format, starting with revenues, followed by expenses, and finally arriving at net income or a net loss.  

The balance sheet and income statement are essential financial statements that provide valuable information for evaluating a company’s financial health and performance. They are often used together to understand a company’s financial situation comprehensively.  

Endnote

In conclusion, the balance sheet and income statement are two fundamental financial statements that provide different perspectives on a company’s financial health and performance. While both statements are essential for understanding a company’s overall financial position, they serve distinct purposes and focus on different aspects of the business. The balance sheet provides a snapshot of a company’s financial position at a specific time. It summarizes its assets, liabilities, and shareholders’ equity, giving stakeholders an understanding of what the company owns and owes. On the other hand, the income statement, also known as the profit and loss statement, presents a company’s financial performance over a specific period, typically a quarter or a year. It outlines the revenues generated and expenses incurred and ultimately calculates the net income or loss.  

Also Read: How to Read And Understand the Balance Sheet

Farwah Jafri

Farwah Jafri is a financial management expert and Product Owner at Monily, where she leads financial services for small and medium businesses. With over a decade of experience, including a directorial role at Arthur Lawrence UK Ltd., she specializes in bookkeeping, payroll, and financial analytics. Farwah holds an MBA from Alliance Manchester Business School and a BS in Computer Software Engineering. Based in Houston, Texas, she is dedicated to helping businesses better their financial operations.