Financial statements are crucial for any business. However, two financial statements are more relevant than others. These are the Balance Sheet and the Income Statement. Out of the five financial statements, these two are always a requirement and prepared by companies. Both of these statements, however, show different aspects of a business.
What is a Balance Sheet?
A Balance Sheet often referred to as the Statement of Financial Position is a fundamental financial statement. It provides an overview of a company’s accounting balances categorized under Assets, Liabilities, and Equity. The Balance Sheet follows the accounting equation, which states that at any time, the total assets of a company will be equal to the sum of its total liabilities and equity.
The Balance Sheet shows a company’s financial position in the form of balances. It provides stakeholders with a snapshot of the company at any given date. Unlike the Income Statement, the Balance Sheet does not represent balances for a specific accounting period. It shows all the balances carried forward from the time of incorporation of the company.
The primary usage of the Balance Sheet is to determine if the company has enough assets to cover its financial obligations in the form of liabilities and equity. However, depending on the type of stakeholder or user of the Balance Sheet, its usage may change. For example, shareholders may be interested in their equity show in the Balance Sheet rather than the liabilities.
On the other hand, financial institutions or lenders of a company may be interested in its assets and liabilities. By using the Balance Sheet, these stakeholders can determine the creditworthiness of a company. Based on this information, they can make decisions on whether to provide the company with a loan or not.
What is an Income Statement?
An Income Statement, also known as Profit or Loss Statement, is another fundamental financial statement. It shows the profits of a company by taking its revenues and deducting all its expenses from it. The Income Statement is the favourite financial statement for shareholders or other stakeholders interested in the company’s profits or performance.
Unlike the Balance Sheet, the Income Statement does not have balances carried over from previous periods. It shows the company’s performance for a specific period, usually quarterly or annually. The main components of the Income Statement are revenues, expenses, and profits. Companies usually further classify their expenses and profits for a better view of their operations.
The primary usage of the Income Statement is for stakeholders to determine if a company is profitable. Almost all stakeholders of a company are interested in its profit- or loss-making potentials. Even investors prefer the Income Statement as it provides them with an idea of how much returns they can get if they invest in the company.
For some stakeholders, the revenues or expenses of the company may also be critical, which the Income Statement shows. For example, the management of the company would be interested in how much expenses the company incurs, so they can reduce them and increase profits.
Conclusion
There are two fundamental financial statements that stakeholders and companies prefer. These are the Balance Sheet and the Income Statement. Firstly, the Balance Sheet shows a company’s financial position at any given time. The Income Statement, on the other hand, presents its performance for a specific period.
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