The Difference Between a Balance Sheet and an Income Statement

In this article:

• Balance Sheet: Assets, Liabilities, Equity
• The Balance Sheet Equation
• Income Sheet: Revenue and Expenses
• What is Net Income

Entrepreneurs and first-time business owners can easily become overwhelmed when they run across terms like “balance sheet,” “income statement,” “equity,” and “liabilities.” But as overwhelming as they may feel at first, these are terms and concepts you’ll need to be intimately familiar with if you are to succeed in business. Thankfully, they aren’t that hard to grasp.

Balance sheets and income statements are two tools that give you a full financial picture of your business from all angles. And in this article, we’ll talk about what they are and how they’re different so you can understand your business better.

Balance Sheet: Your Business at a Glance

A balance sheet presents a snapshot summary of the company’s assets, liabilities, and equity at a moment in time. The report captures your business’s finances so you can have all the information you need to make necessary business decisions.

Let’s review the details of this report so you can see the value in regularly checking your balance sheet.

1. Assets: The Business’s Valuables

Assets represent the resources that a business owns or controls, which are expected to provide future economic benefits. Assets can be broken down into two categories:

• Current assets are expected to be converted to cash or used within a year. Examples include cash, accounts receivable, and inventory.
• Non-current assets are long-term assets that can’t easily be converted into cash within one year. These are things like property, equipment, and intangible assets like patents, copyrights, and branding.

2. Liabilities: The Business’s Obligations

Liabilities are obligations the business must fulfill. They represent amounts the business owes to lenders, suppliers, employees, and other parties.

• Current liabilities are obligations expected to be settled within a year. Examples include accounts payable and short-term loans.
• Long-term liabilities are obligations due over a period longer than a year, things like mortgages and bonds payable.

3. Equity: Ownership’s Residual Claim

Equity represents the owner’s claim after all liabilities have been settled. In essence, it’s the value that remains for the business’s owners if all assets were sold off and all debts paid.

• Owner’s Capital: This is the initial amount invested by the owner or owners into the business.
• Retained Earnings: These are profits earned by the business that haven’t been distributed to the owners but are reinvested into the business instead.
• Share Capital: If a business has shareholders, this represents the total value of shares that have been issued.

The Balance Sheet Equation

The balance in the balance sheet comes from the fundamental equation:

Assets = Liabilities + Equity

Run the numbers for this equation to find out if both sides of the balance sheet are equal or ‘balanced.’ This is rooted in the double-entry bookkeeping system, where each financial transaction affects at least two accounts, ensuring that the books always balance.

Income Statement: Your Performance Over Time

Your income statement shows your profits and losses over time, outlining your revenues and expenses. The income statement represents your overall performance as a business, whether over a month, quarter, or year.

Let’s define the terms that make up your income statement.

1. Revenues: The Topline of Your Business

Revenue is called the “top line” because it is listed at the top of the income statement. Revenue will list the line items of cash inflow from primary operations and total it up before any costs are subtracted.

Types of revenue include the following:

• Sales Revenue: This is income from selling goods or delivering services. For a retailer, it might be sales from clothing, while for a consultant, it’s fees earned from providing advice.
• Interest Revenue: Businesses that have investments or significant amounts in high-interest accounts might earn income in the form of interest.
• Other Revenues: Some businesses might have secondary ways of earning, like franchising fees, royalties, or licensing.

2. Expenses: The Cost of Doing Business

Expenses are the costs of running the business as you generate revenue. Everything you spend on generating revenue and maintaining business operations is listed as expenses.

• Cost of Goods Sold (COGS): Direct costs attributable to the production of the goods a company sells. This includes the cost of raw materials and the direct labor for production.
• Operating Expenses: These are the costs not directly tied to making a product or performing a service. They can include rent, employee pay, utilities, marketing, and depreciation.
• Interest Expense: Cost incurred on any borrowings – bonds issued, loans secured, or any other form of financial leverage.
• Taxes: Income taxes that the business must pay to the government.

3. Net Income: The Financial Health Indicator

Net income is the bottom line. It indicated the company’s profitability over a period of time. After all expenses, including taxes, are accounted for, we arrive at the net income. If this number is positive, the company has made a profit. If negative, it’s a loss.

Why Are These Statements Crucial?

Here are three scenarios where you’ll need a strong understanding of your balance sheets and income statements:

• For Business Growth: Understanding these statements provides insight into what’s working in your business and where improvements are needed. It helps make informed decisions about investments, cost-cutting, and growth strategies.
• For Securing Financing: Financing companies rely on these financial statements to assess the health of a business. They provide a clear picture of your business’s ability to repay loans and funding.
• For Stakeholders: Investors, partners, and even potential buyers might want a peek into these statements to evaluate the worth and performance of your business.

Conclusion

If these terms and concepts are new to you, don’t worry—they’ll soon become second nature. Keep your finances up to date, use an intuitive bookkeeping software, and just keep reviewing them on a regular basis. You’ve got this!

At Biz2Credit, we’re committed to helping business owners navigate the financial aspects of their businesses. Remember, understanding your financials is not just about securing the right funding; it’s about ensuring your business’s long-term success and growth.