As a Business-of-One, you have many, many hats to wear. Some of your duties are made up of the things you love to do…the reason you’re in business in the first place. And some, well… not so much. Like trying to figure out the nuances of the “balance sheet vs income statement” question.
Short answer: They’re similar in many respects and work together, but they perform different functions. For more insight on this, read on!
What is the difference between a balance sheet and an income statement?
The balance sheet shows your company’s assets, liabilities, and equity – basically the financial health of the business at a specific point in time. It helps you figure out if you have enough money to cover your expenses and other financial obligations.
The income statement shows a cumulative view of your total revenues and expenses over a longer period – how the company’s performing. This information is key, especially if you’re just starting out in business. It prepares you for when you may need to pivot quickly for better results.
What goes on an income statement vs balance sheet?
Throughout time, business owners across the centuries have pondered the age-old question: what goes on an income statement vs a balance sheet. Seriously, though. Unless you’re an accounting whiz kid, it’s very easy to get these two important docs confused since they both report aspects of your company’s finances.
The income statement and the balance sheet work together to illustrate how well your business is doing, how much it’s worth, and areas that could be improved. The income statement shows you what your company has taken in, what it’s paid out, and your total profit or loss for a specific period in the year.
The income statement shows:
- Sales: revenue or what your business has generated from goods and services sold
- Costs: the amount you spent on labor and materials to make the goods and services
- Gross profit: your sales minus your costs
- General costs: building rent, software, office supplies, wages, utilities, and more
- Earnings before tax: the money your company brought in before taxes
- Net operating income: your sales minus costs minus operating expenses
- Other income or expenses: income and expenses that aren’t related to the day to day operations, like interest income or depreciation expenses
- Net income: your net income minus other income and expenses total earnings minus total expenses, including taxes
The balance sheet can be divided into two columns. One side shows the company’s short- and long-term assets and the other side shows its liabilities and equities for a specific point in time. With the two sides (and here’s the catch) needing to match or, you’ve probably guessed it, balance.
The balance sheet is typically prepared monthly, quarterly, or annually. You could prepare one whenever you need to show your company’s financial position.
The balance sheet shows your assets:
- Account balances: sum of money in checking and savings
- Accounts receivable: what other people owe you
- Inventory on hand
- Fixed assets: items your business owns, like equipment and machinery
- Intangible assets: trademarks, patents and domain names
It also shows your liabilities:
- Accounts payable: what you owe other people
- Current liabilities: short terms loans that you can pay off within one year, like credit card balances
- Long term liabilities: debt that will take you more than 12 months to pay off, like a business loan
And finally, it shows your equity:
- Shareholders equity: net assets, capital invested, revenue
Which is more important: income statement or balance sheet?
Short answer? It depends. And, truthfully, how can you choose a favorite? You love ALL your hardworking financial documents equally. Your income statement and balance sheet, along with a third doc, the cash flow statement (more on this later), paint the company’s entire financial picture. Each document has its own talents and quirky personality.
However, many small business owners say the income statement is the most important as it shows the company’s ability to be profitable – or how the business is performing overall. You use your balance sheet to find out your company’s net worth, which can help you make key strategic decisions. But, the balance sheet doesn’t show the whole story on its own.
What comes first: income statement or balance sheet?
This is not like the existential “chicken or egg” question. The income statement or Profit and Loss (P&L) comes first. This is the document where the income or revenue the business took in over a specific time frame is shown alongside expenses that were paid out and subtracted. If your revenue was greater than your expenditures, your business made a profit.
If your expenses were higher than your revenue, your business ran at a loss for that period. This can be a bit of a bummer, but good intel to have so you can adjust accordingly.
The balance sheet contains everything that wasn’t detailed on the income statement and shows you the financial status of your business. But the income statement needs to be tallied first because the numbers on that doc show the company’s profit and loss, which are needed to show your equity.
Should the income statement and balance sheet match?
You will not get your income statement and balance sheet to match – even if you are talented in the accounting arena. That’s because they’re not supposed to match because these two reports feature different line items. However…they do play off one another in that any revenue increases on the income statement will show up as an increase of equity on the balance sheet.
So how do you know if your balance sheet is correct and does indeed balance? Your liabilities and equity, when added together, should equal your total assets. If these two figures match, your balance sheet is correct. (Oh, happy day!)
If they don’t balance, your biz may have some accounting issues. This is when you do yourself a HUGE favor and get help from an accounting pro. You know, someone who lives and breathes this stuff – like a bookkeeper.
Wait, what? You don’t have a bookkeeper? Ok, you should seriously consider getting a bookkeeper. The modest outlay could save you boatloads of cash at tax time, not to mention save you from pulling out all your hair trying to balance your books.
What are examples of financial statements?
Your company’s financial statements are made up of three important documents: the balance sheet, the income or Profit and Loss statement, and the cash flow statement. It’s easy to get confused on the different functions of your balance sheet vs income statement vs cash flow statement.
The balance sheet summarizes the company’s balances and tracks what it owns, what it owes, and how much equity is available – either for the owner and/or for shareholders. The income statement details your total revenues and expenses over a longer period to show you how the company is performing overall.
The cash flow statement shows (ahem) the flow of cash in and out of the business by recording the changes in both the balance sheet accounts and the income statement. Together with the balance sheet and income statement, the cash flow statement gives you your “cash position.”
There you have it. Hopefully, you’re now clearer on your income statement v balance sheet. And being the savvy sole proprietor you are, you probably noticed that the same question was asked and answered in several different ways.
To quote legendary salesman and motivational speaker, Zig Ziglar: “Repetition is the mother of learning, the father of action, which makes it the architect of accomplishment.” So go ahead and read over the magnificent seven one more time…
It’s a lot to take in, especially if financial statements are not your thing. But you’ve got this! After all, you took the biggest leap and became a solo entrepreneur! Now that takes guts and smarts.
Janie Basile is a freelance content creator from Scotland with 20 years’ experience crafting content for insurance and technology startups and financial services companies. After taking the leap, a few years ago, into the world of freelancing, she is fully immersed in learning all there is to know about financially managing a Business-of-One. She enjoys passing that intel on to other solo entrepreneurs in the form of interesting and informative articles. Her work has appeared in places like TechCrunch, Redfin, TheZebra, and Freedom Financial.