Excel template balance sheet and income statement

Understanding the relationship between an income statement and balance sheet - Similarities and Differences

Article written by : Ranita Mukherjee

It is important to know about the income statement and balance sheet that play an important role in showing the financial status of the company. Let us understand each of them in detail before delving into the similarities and differences between them.

What is an Income Statement?

An income statement is considered an important part of the company where it helps in showing the profit and loss of a company over a trading period which is usually one year. In the case of big companies, it tends to show quarterly accounts. The income statement is divided into three parts which can be shown in one document.

Trading account- It shows the sales of the company. It includes the cost of purchasing the stock. When its cost is deducted from the sales figure, gross profit is left after that, which is termed as the summary of the trading account.

Income statement- This is also known by the name as profit and loss account which helps in the identification of other expenses of the business. The expenses include electricity bills along with rental payments, wages along with loan repayments. Once all the total expenses are calculated, the amount can be easily deduced from the net profit of the company. Net profit is also known by the name of  operating profit because it appears after the operating expenses. The figure which is arrived at will show the actual profit of the concern along with showing the performance indicator of the concern.

Appropriate account- This is the third section of the income statement, which shows how the company distributed its profit.

• Tax should be paid from net profit
• The remaining amount should be distributed to all shareholders of the company who have invested more money into the business.
• If the concerns are into losses then there is no need to pay any tax along with shareholders profit.
• Retained profit is also part of income statements where the profit is retained by the business in order to keep them reinvested for future periods.
• If there is any loss, then it should be moved to next year. It also includes in the calculation of the profit in the next year.

 Balance sheet

The balance sheet displays the items of the company which owned them along with the money they owed. It shows how the business is funded. It includes the top sections, while the bottom section shows the different sources of finance. The items of value are termed assets. It includes 2 types of assets fixed which won’t convert into cash in the future. These are also known as operational assets that cover machinery along with fixtures along with fittings and vehicles.

It also includes those assets which are intangible in nature like goodwill. It includes current assets that will help the business to convert them into cash. It is used to pay the bills along with purchases along with general overheads. Money that is owed by the business or company is known by the name as a liability. It is different from the expenses in the income statement. Liability is shown in the top half of the current liabilities. The value of the current liability will be deducted from the value of the current assets. It will show the working capital of the company which is also known by the name as operating income.

Income statements and balance sheets are considered important financial statements that give the full detail about the financial accounting of the company. The balance sheet on one hand gives the full details about the company’s assets along with liabilities for a particular period of time. On the other hand, an income statement gives the full details about the income and expenses for a particular period of time. A balance sheet is made up of three items that include assets along with liabilities and owner's equity. It updates the financial health of the company at a particular period of time.

In the balance sheet, company assets should be equal to the liabilities and owner's equity. It tells the company’s financial status at the end of the one financial year. It also plays an important part in making the important decisions of the company regarding the financial part. On the other side, an income statement is used to update the business income and expenses of the particular period. Revenues earned by the business are recorded as credits and expenses are recorded as the debit. Income statements are also known by the name as profit and loss statements. In other words it is used to show the profitability of the business.

An income statement shows the net income of the company. If revenues and income earned by the business are more than the expenses and losses, then the company is in profit. On the other hand, if the revenues along with income are less than the losses and expenses, then the company is at a loss. The balance sheet gives detailed instructions than the income statement which gives the full details about the assets and liability.

Differences between Income statement and balance sheet

Let us try to understand the difference between income statement and balance sheet, based on the following parameters:

Period- A balance sheet helps in showing the financial status of the company at the end of one financial year. In other words, we can say that the balance sheet shows the current assets and liabilities for a particular period of time. On the other side, an income statement is used to show the income and loss for a particular period of time.

Items covered- The balance sheet will include assets along with liabilities and equity. On the other hand, an income statement will include revenues along with expenses that will result in net profit or a net loss.

Role of both- Balance sheet items are compared to each other in order to arrive at the liquidity of the business. In income statements, items are compared with the sales part in order to arrive at gross margin percentage along with operating income and net income.

Beneficial- A balance sheet is mostly used by the management in order to know whether the business has liquidity in order to meet its obligations. On the other side, an income statement is used to examine the results and come out with the solution if something needs to be changed or correction needed.

Lenders and creditors- creditors along with lenders used the balance sheet in order to see if the balance sheet is over-leveraged which will guide them to extend their additional credit to the entity. On the other hand, an income statement is used to see or decide about the business whether it is generating profit to pay off its liability.

Importance- Income statement and balance sheet statement are important but the most important statement is an income statement that will help in showing the actual result of the company at the end of the financial year. A balance sheet will help you to know the financial statement at the end of the particular period. It shows how much assets and liability are owned by the company.

Performance- The balance sheet will not be able to show the performance of the company but on the other hand income statement will show the company’s performance.

Importance of Income statement and balance sheet

Income statement and balance sheet are important to be prepared by the company as they give the following information:

• Provides information about the results of operations in the business along with financial positions and cash flows
• It will show the full and acute information about the company wealth
• They play an important role for the management where they will be taken important decisions like an expansion of the business
• They are important for the shareholders themselves as they will get some share after the company arrives at a profit. It is also used to pay off the taxes. But on the other hand, if there is a loss in the concern, then no shareholder is entitled to receive some share for that
• It is also best for workers as the financial statement is prepared at the end of the concern. If the company is running into profit, then in that case, the workers of the company are entitled to receive the bonus that totally depends upon the profit of the company. It could be only possible after the preparation of the account.
• This information is used by the person for decision-making and for allocation of resources.
• It will help the companies to make decisions regarding the credit where they can increase the limit of the credit.
• It will also help the companies in making the investment decisions if they generate more profit for a particular period.
• It will also help the companies in making taxation decisions that will help the company in other ways.
• It will also help the companies in maintaining the retained profit that will help the companies in making the right decisions about purchases. This will prove fruitful for the business in the areas of expansion.

The above decisions of the company can be taken against after the preparation of financial accounts that will prove to be an effective solution for the company in terms of sales and profit. Apart from that, balance and income statements give the clear idea about the company’s wealth which can be used further for the expansion of the business. Today, there are many accounting tools which help people in easy handling of the reports. They can easily see the reports from anywhere and anytime. Along with that, they can also take important decisions of the company reading its expansion part.

Thus from the above points, we can find easily that balance and income statements are important for the concern one will display the income earned for a particular period of time, while the other will show the financial status of the company at the end of the particular period. Both are important to prepare as they show a clear picture of the company in terms of profit and loss. It can be easily viewed by preparing both the statements.