Profit and Loss Statement vs Balance Sheet, what you need to know.
Expanding your company is an exciting time, but to know if it is the right time for growth, you need to be clear about where your financial health and whether your business is ready to support the growth. The best way to determine the financial health of your business is through the financial statements, which can be generated either monthly, quarterly, or annually. For small or new businesses, generating these statements monthly can help you to identify issues and areas of growth quickly, allowing you to pivot in order to increase profitability over the long term. With that in mind, let’s learn differences between a profit and loss statement vs balance sheet.
What is a Balance Sheet?
A balance sheet reports your assets, liabilities, and shareholder equity for a specific period. It provides a snapshot of what you own and owe, but also how much has been invested by your shareholders. You can utilize the balance sheet to conduct fundamental analysis or to calculate financial ratios.
What’s included in a balance sheet?
This is an overview of the state of your company’s finances, but it cannot give you a sense of trends playing out over a longer period of time on its own. You would need the entire group of financial statements to clearly identify trends and potential issues. Your balance sheet includes a list of your assets, liabilities, and equity.
There is a general order of accounts within your current assets, which include the following:
- Cash and cash equivalents
- Marketable securities
- Accounts receivable
- Inventory
- Prepaid expenses
- Long-term assets, such as investments, fixed assets, and intangible assets
There are also several types of liabilities, which include the following:
- Current liabilities – These incorporate the portions of long-term debt due within the next 12 months.
- Interest payable
- Wages payable
- Customer prepayments
- Dividends
- Earned or unearned premiums
- Accounts payable
- Long-term liabilities include interest or principal on bonds issued, pension fund liability, deferred tax liability, and depreciation calculations.
Shareholder equity is money attributed to the business owners or shareholders. It is also known as the net assets since it is equal to the total assets minus its liabilities or debt owed to its shareholders. Retained earnings are also noted on the balance sheet, and these are the net earnings that are reinvested into the company or distributed to shareholders as dividends.
Regardless of the size of your company, there are many benefits to reading, analyzing, and understanding your balance sheet, particularly when you include the information from your profit and loss statement (P&L).
What is a Profit and Loss Statement?
A profit and loss statement gives you a snapshot of your total profits, liabilities, and expenses by breaking down your profit and loss line by line for a specific period, which could be a month, a quarter, or a fiscal year. They are presented on either a cash or accrual basis. With the information provided, investors, lenders, and the leadership of a company can analyze its financial health. Many companies incorporate the P&L into their business plan, as it shows how much profit or loss was generated.
What’s included in a profit and loss statement?
Your P&L will include three basic elements: revenue, expenses, and net income. When your P&L becomes more advanced, reflecting the expansion of your business, then it can also incorporate your operating profit and earnings before interest, taxes, depreciation, and amortization. Here are the following areas you should see on every P&L statement:
- Gross revenue – the amount of money received as payment for products or services
- Cost of Goods Sold (COGS) – expenses for everything involved in creating your product or service, such as manufacturing materials, contractors, and labor. However, it doesn’t include your operating expenses.
- Net revenue – the gross revenue minus your COGS, otherwise known as your gross profit or gross income.
- Expenses – any fixed or operating expenses required to run your company, including salaried employees, advertising, marketing, utilities, rent, and insurance.
- Net profit – also called net income, this is the net revenue minus the total expenses. If this calculation is negative, then it is called a net loss.
With this information in mind, let’s do a comparison of the balance sheet versus the P&L statement.
Comparison Chart: Profit and Loss Statement Vs Balance Sheet
There are several formatting differences that you will notice when comparing your balance sheet with your profit and loss statement. Here is what you need to know about each of them and how that impacts the information provided.
Format of Balance Sheet
There are several different formats your balance sheet can take, and each presents the information in a different way, which can facilitate various types of analysis. These include the following:
- Classified balance sheet – groups assets and liabilities into current and non-current categories.
- Vertical balance sheet – presents assets and liabilities in one column and amounts in another column, descending in order of liquidity.
- Comparative balance sheet – shows changes in assets, liabilities, and owners’ equity over a period of time, typically two years.
- Common-size balance sheet – expresses each item as a percentage of total assets, liabilities, or owners’ equity to facilitate comparison across different periods.
Format of Profit and Loss Account
There are two different types of P&L statements, which are based primarily on the period of time they cover.
Monthly profit and loss template – This requires regular reporting and detailed information about transactions. By showing the information in monthly columns, more detail is visible, and line items can include revenue, COGS, interest expense, earnings before tax, and net income.
Annual profit and loss template – This follows the same format and structure as your monthly P&L but doesn’t have a total column that sums up each period. It can easily be altered to add or remove rows as necessary and can help you analyze your P&L year over year.
Key Differences Between Profit and Loss Statement Vs Balance Sheet
There are several key differences between the P&L and balance sheet, particularly the information presented and what it means. The P&L summarizes the company’s performance over a specific period, while the balance sheet reflects the company’s value at a specific date.
Order in which they are prepared
The P&L statement is typically prepared before the balance sheet, but they work together to provide a comprehensive view of your company’s financial health.
Information they contain
The contain information about your expenses, revenue, liabilities, and assets. When used together, these financial statements can assist you in determining if your business is profitable and whether it is carrying too much or too little debt.
Insight into the company’s financial position
These two financial statements provide a snapshot of your financial health, including insights into its performance, operations, and cash flow. They provide information about your company’s revenue, expenses, profitability, and debt.
To understand a company’s financial position, you should review and analyze the financial statements to calculate certain ratios. These ratios help investors to understand how well the company is performing in comparison to its competitors and industry benchmarks.
When the statements are created
These statements can be created at any time but are typically created at specific points throughout the year. Many businesses opt to create them monthly, quarterly, or annually based on their business model and whether they have any reporting requirements.
When to Use Each Statement
Each statement will give you unique information markers, so it is important that you understand which financial statement to focus on based upon the information you are trying to find.
Assess more financial information
If you are looking for comprehensive financial information, particularly the current assets and liabilities, then you want to utilize the balance sheet since it will give you a definitive financial picture for a specific date in time, as well as detailed information about where the company’s funds are currently being used and how much debt the company is carrying.
Compare financial health from two dates
A P&L statement can help you to identify trends and compare your financial health across two different dates. That means you can see if there are issues with expenses or if you are seeing increasing sales in different quarters. You can also use this information to capitalize on the products and services generating the most revenue.
Determine if the company is profitable
Your P&L statement can tell you if your company is profitable, based upon the current income and expenses. It will also be able to define whether you are operating at a loss or not and identify key areas where adjustments can be made to generate a profit or minimize your losses.
Measure financial transaction accuracy
Your P&L statement measures the accuracy of financial transactions. However, it is essential to note that this is not based solely on one financial statement. Financial statement assertions are claims a company makes about the fundamental accuracy of its financial information.
Monitor cost and expense efficiency
Using a P&L statement, you can compare costs and expenses over time to determine if your company is using its resources efficiently or if changes can be made to maximize savings without compromising quality and overall manufacturing timeframes.
Frequently Asked Questions
Can accounting software help you manage income statements and balance sheets?
Yes, your accounting software can help you to generate these financial statements for different periods and also inport the information from your transaction history completed by your bookkeeper.
What are the 5 types of financial statements?
There is the balance sheet, the P&L statement, cash flow statement, the statement of shareholder’s equity, and footnotes to financial statements.
Is an income statement the same as a profit and loss statement?
They are often used interchangeably, but the income statement is more comprehensive than the P&L statement.
Which is more important, a profit and loss, or balance sheet?
Both are equally important, since together, they give you a more complete picture of the financial health of your company.
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In Summary
When it comes to analyzing the financial health of your company, you need to be familiar with all aspects of the financial statements. Your balance sheet and P&L statement both provide key pieces of information that can be helpful in determining your long-term strategy, as well as determining if opportunities are right for your company in its current financial state. Working with your bookkeeper, you can ensure that these statements are accurate and up-to-date with every analysis.
