Profit and loss statement vs balance sheet: The key difference
The balance sheet and the profit and loss statement are financial statements that your partners or your banker will ask you regularly to assess the health of your business. In addition, the preparation of the balance sheet and the profit and loss statement is mandatory for most businesses.
Have you ever confused these two terms? Indeed in everyday language, these two financial statements are often named one in place of the other. In this article, we'll explain all the information you need to remember to understand the difference between a balance sheet and a profit and loss statement.
Before indicating the differences between these two statements, it is important to understand their definitions, purpose, and main characteristics.
Let’s find it out in this article!
What is the balance sheet?
An accounting balance sheet includes the assets (what is owned by a business) and the liabilities (what a business has as a resource).
The balance sheet is part of the financial statements of a business in the same way as the income statement and the appendices. The balance sheet is often compared to a photograph of the assets of a business at the end of a financial year or on intermediate dates.
This statement is mainly used by third parties (banks, customers, shareholders, administrations, investors ...) in order to know the income value of the business and to ensure its solvency.
This statement is also used to determine taxable income and can be prepared by managers and investors to provide internal analyzes. To ensure the transparency and veracity of balance sheets, this statement must generally be certified by an auditor.
Your business's balance sheet changes every day, as does your private wealth. For example, do you want to buy a new computer or a new product? You will increase your assets but you will decrease your cash flow if you pay them cash.
Conversely, you will increase your liabilities if you have a debt with your supplier. If you buy a house or a car as an individual, it's the same thing.
On the other hand, if you repay a loan or if you pay dividends to a partner, you will reduce your liabilities. But your business’s assets will also be smaller since you will be taking out cash.
There is therefore a permanent balance between assets and liabilities on the balance sheet. The total debits are therefore equal to the total credits.
The balance sheet is a necessary step, it makes it possible to analyze the financial situation of the business or its prospects when it is a provisional balance sheet included in the business plan of a creator.
In general, balance sheets take the form of a summary table divided into two parts: assets and liabilities.
Balance sheet assets
The assets on the balance sheet are located to the left of the statement. The assets on the balance sheet represent the means of production of the business and everything it has at a specific time. But this statement will also show the potential dilapidation of your production tool and your difficulties in getting paid by your customers.
Assets, which represent all of what your business owns, includes:
- Fixed assets: these can be financial fixed assets (equity securities in other businesses and everything related to them, such as loans and receivables), tangible fixed assets (equipment, buildings, etc.), and intangible assets (patents, software, research, and development costs, etc.)
- Current assets: they designate cash, stocks, and customers.
The liabilities of the balance sheet
Liabilities, which represent all of the business's debts, include:
- the capital,
- the result,
- debts, which are broken down into several items: tax, social debits, and operating expenses.
The liabilities of this financial statement will show the financial structure of your business, namely whether your activity is holding up thanks to the results generated or thanks to the banker's loans and overdrafts, and supplier delays. The assets and liabilities of the statement are always in equilibrium.
(Use of funds)
(Sources of funds)
|What the company owns:
||What the company owes:
What is the profit and loss statement?
The profit and loss statement is the film of your company’s activity. The profit and loss statement is the financial statement that will allow you to see whether your business is generating a profit or a loss.
Unlike the balance sheet which is a photo on a given date, the profit and loss statement is dynamic because it traces the income/resources and all the charges/expenses of the company between two dates.
The net income for the year is the difference between expenses and income. This net income represents the sum of the operating income (relating to the current activity of the business), the financial income (which results from the financial operations of the business), the exceptional income (does not result from the normal activity of the business), less tax on income and employee participation.
If the balance is in credit, then it is a profit. If the balance is debit, it is a loss. This financial statement is primarily useful for looking at how your business has gained income and has grown from year to year.
For associations, we speak of a surplus (if income is greater than expense) or deficit. Most often, the profit and loss statement is drawn up from the first day of the financial year to the close of the financial year. But it is possible to establish an intermediate statement during the year. It is also possible to establish a provisional income and expenses statement for the years to come.
The profit and loss statement includes:
- Expenses: they include operating expenses, personnel expenses, taxes and duties, supplier debts, supplies expenses or subcontracting, employee expenses, etc. That is to say, all the expenses which your business must face;
- Income: it includes operating income, turnover, financial income, and exceptional income. We can say it’s the money resource of the company.
|THE PROFIT AND LOSS STATEMENT|
|Includes hat the company has to pay:
||Includes what the company earns:
What is the difference between the profit and loss statement and the balance sheet?
The balance sheet corresponds to the financial health of the business at a specific moment. It is a financial statement that is often interesting to bankers when taking a loan, for example, to check the financial stability of the business.
While the profit and loss statement is used to calculate the business's net income. This financial statement is therefore used to know whether a business gets richer or poorer over the years.
The compositions of these two financial statements are also different.
The balance sheet includes 2 parts: Assets and liabilities
- Assets: Fixed assets and current assets
- Liabilities: capital, equity, income, reserves, debts
The profit and loss statement includes 2 parts: Revenues and expenses
The balance sheet and the profit and loss statement are also different in their presentation:
- For the balance sheet, the liabilities are on the right, and the assets are on the left of the statement table.
- The profit and loss statement is a list of amounts that are added or subtracted: revenue is at the beginning of the statement and expenses are below.
In the balance sheet, the liability is equal to the asset while in the income statement the difference between income and expenses is equal to the income or loss of the business.
Do they have anything in common?
Even if these financial statements are different in form and they do not present the financial analysis from the same point of view, the balance sheet and the income statement speak of the same thing: the activity of the business in a given period.
Bankers or an accountant can check the solvency and financial report of your business. Moreover, both of these statements are always balanced.
Finally, these financial statements are also used together for the preparation of your annual accounts. They will allow the accountant to determine the amount of income tax you owe.
In summary, although the balance sheet and the profit and loss statement are different in their approach, these two financial statements both describe the state of health of your business. And it is on the basis of a good balance of these two financial statements that you will be able to base your financial plans for tomorrow. So having a good profit and loss statement is a must, but with a healthy balance sheet, it's even better!