The balance sheet and the profit and loss聽(P&L) statement are two of聽the three financial statements companies聽issue聽regularly. Such statements provide an ongoing record of a company's financial condition and are used by creditors, market analysts and investors to evaluate a company's financial soundness and growth potential.聽The third financial statement is called the cash-flow statement.

Key Takeaways

  • A balance sheet reports a company's assets, liabilities and shareholder equity at a specific point in time.
  • A balance sheet provides both investors and creditors with a snapshot as to how effectively a聽company's management uses its聽resources.
  • A profit and loss (P&L) statement summarizes the revenues, costs and expenses incurred during a specific period of time.
  • A P&L statement provides information about whether a company can generate profit by increasing revenue, reducing costs, or both.

Balance Sheet聽

A balance sheet reports a company's assets, liabilities and shareholder equity at a specific point in time. It provides a basis for computing rates of return and evaluating the company's聽capital structure. This financial statement provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.

The balance sheet shows a聽company's聽resources or assets, and it also聽shows聽how those assets are financed鈥攚hether through debt under聽liabilities or by issuing equity聽as shown in shareholder equity. The balance sheet provides both investors and creditors with a snapshot of how effectively a聽company's management uses its聽resources. Just like the other financial statements, the balance sheet is used to conduct financial analysis and to calculate financial ratios. Below are a few examples of the items on a typical balance sheet.

Assets

  • Cash and Cash Equivalents. These are the most liquid assets, which may include Treasury bills (T-bills),聽short-term certificates of deposit (CDs) and cash.
  • Marketable Securities. This category includes equity and debt securities for which there is a liquid market.
  • Receivables. Also known as accounts receivable, this represents money owed to the company by customers.
  • Inventory. This area covers all the goods available for sale.

Liabilities

Shareholder Equity

Shareholder equity is equal to a firm's total assets minus its聽total liabilities聽and is one of the most common financial聽metrics聽employed by聽analysts聽to determine the聽financial health聽of a company. Shareholder equity represents the net value of a company, meaning the amount that would be returned to shareholders if all the company鈥檚 assets were liquidated and all its debts repaid.

Retained earnings聽are recorded under shareholder equity and聽refer to the percentage of聽net earnings聽not paid out as聽dividends but retained by the company either to be reinvested in its core business or to pay the debt.

Trial Balance vs. the Balance Sheet

It's important to note that the trial balance is different from the balance sheet. This is聽an internal report that stays in the accounting department.聽The聽balance sheet, on the other hand, is a financial statement聽distributed to other departments,聽investors, and聽lenders.

The trial balance provides financial聽information at the account level,聽such as general ledger accounts,聽and is therefore more granular. Eventually, the聽information in the trial balance is聽used to prepare the financial statements for the period.

In contrast, the balance sheet aggregates multiple accounts, summing up the number聽of assets, liabilities and聽shareholder equity聽in the聽accounting records聽at a specific time.聽The balance sheet includes outstanding expenses,聽accrued income, and the value of the closing stock, whereas the trial balance does not.聽In addition, the balance sheet must adhere to聽a standard format as described in an accounting framework, such as the聽International Financial Reporting Standards (IFRS)聽or the聽generally accepted accounting principles (GAAP).

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Comparing the P&L Statement and the Balance Sheet

Profit and Loss聽(P&L) Statement

A P&L statement, often referred to as the income statement,聽is a聽financial statement聽that summarizes the revenues, costs, and expenses incurred during a specific period of time, usually a fiscal year or quarter. These records provide information about a company's ability (or lack thereof) to generate profit by increasing revenue, reducing costs, or both. The P&L statement's many monikers include the "statement of profit and loss,"聽the "statement of operations," the "statement of financial results," and the "income and expense statement."

Top Line and Bottom Line

The P&L statement provides the top and bottom line for a company. It聽begins with an entry for聽revenue, known as the top line, and subtracts the costs of doing business, including聽the cost of goods sold,聽operating expenses,聽tax expenses,聽interest expenses,聽and any other expenses sometimes referred to as "extraordinary" or "one-time" expenses.聽The difference, known as the bottom line, is聽net income, also referred to as聽profit聽or聽earnings.聽

Realized Profits and Loss

The P&L statement聽reveals the company's realized profits or losses for the specified period of time by comparing total revenues to the company's total costs and expenses. Over time it can show a company's ability to increase its profit, either by reducing costs and expenses or increasing sales.聽Companies publish P&L statements聽annually, at the end of the company's fiscal year, and may also publish them on a quarterly basis.聽Accountants, analysts, and investors study a P&L statement carefully, scrutinizing cash flow and debt financing capabilities.

Revenues and Expenses

From an accounting standpoint, revenues and expenses are listed聽on the P&L statement when they are incurred, not when the money flows in or out. One beneficial aspect of the P&L statement in particular is that it uses operating and nonoperating revenues and expenses, as defined by the Internal Revenue Service (IRS) and聽GAAP.

A balance sheet considers a specific point in time, while a P&L statement is concerned with a set period of time.

Balance Sheet vs. P&L Statement

Although the balance sheet and the P&L statement聽contain some of the same financial information鈥攊ncluding revenues, expenses and profits鈥攖here are important differences between them. Here's the main one: The balance sheet reports the assets, liabilities and shareholder equity at a specific point in time, while a P&L statement summarizes a company's revenues, costs, and expenses during a specific period of time.

Purpose of Each Statement

Each document is built for a slightly different purpose. Balance sheets are built more broadly, revealing what the company owns and owes聽as well as any long-term investments. Unlike an income statement, the full value of long-term investments or debts appears on the聽balance sheet.聽The name "balance sheet" is derived from the way that the three major accounts eventually balance out and equal each other. All assets are listed in one section, and their sum must equal the sum of all liabilities and the shareholder equity.

The P&L statement answers a very specific question: Is the company profitable?聽While accountants use the P&L statement to help gauge the accuracy of financial transactions鈥攁nd聽investors use the P&L statement to judge a company's health鈥攖he company itself can review its own statement for productive purposes. Closely monitoring financial statements highlights where revenue is strong and where expenses are incurred efficiently, and the opposite is true as well. For example, a company might notice increasing sales but decreasing profits and search for new solutions to reduce costs of operation.

Profit vs.聽Total Value

The聽P&L聽statement shows net income,聽meaning聽whether or not a company is in the red or black.聽The balance sheet shows how much a company is actually worth,聽meaning its total value. Though both of these are a little oversimplified, this is often how the P&L statement and the balance sheet tend to be interpreted by investors and聽lenders.

It鈥檚 important to note that investors should be careful to not confuse earnings/profits with cash flow.聽It's聽possible for a firm to operate profitably without generating cash flow or to generate cash flow without producing聽profits.

How the Statements Are Calculated

The P&L statement requires accountants to add up the company's revenue on one portion and add up all of its expenses on another. The total amount of expenses are subtracted from the total revenue, resulting in聽a profit or loss. The balance sheet has a few different calculations that are all performed as representations of one basic formula:

Assets = Liabilities + Owner鈥檚 Equity

The Bottom Line

When used together along with other financial documents, the balance sheet and P&L statement聽can be used聽to assess the operational efficiency, year-to-year consistency, and organizational direction of a company. For this reason the numbers reported in聽each document are scrutinized聽by investors and the company's executives. While the presentation of these statements varies slightly聽from industry to industry, large discrepancies between the annual treatment of either document are often considered a red flag.

A firm's ability (or inability) to generate earnings consistently over time is a major driver of stock prices and bond valuations. For this reason every investor should be curious about all of the financial statements鈥攊ncluding the P&L statement and the balance sheet鈥攐f any company of interest. Once reviewed as a group, these financial statements should then be compared with those of other companies聽in the industry to obtain performance benchmarks and understand any potential market-wide trends.