Income Statement vs. Balance Sheet: Understanding the Key Differences

Key takeaways

The income statement and balance sheet are distinct reports created by accountants and reviewed by investors and executives to gauge financial health. Here are some important facts to know:

• The income statement summarizes a company’s profitability over a given period by summing up the revenue and expenses. 

• The balance sheet lists a company’s assets, equity, and liabilities at a given moment. 

• You can begin creating financial reports for accounting by learning more about the differences between income statements and balance sheets.

Explore how you can analyze income statements and balance sheets to gain a clear view of a company’s financial health. If you’re looking to build foundational skills in bookkeeping and accounting, consider the Intuit Academy Bookkeeping Professional Certificate. Learn basic bookkeeping, how to define assets and liabilities, and how to produce financial statements. 

Financial reporting: Income statement vs. balance sheet

The income statement and balance sheet are two common financial statements that companies use to get an overview of their financial health. Both statements use the accrual accounting method, which tracks the entity’s overall economic picture, rather than just tracking cash transactions. 

To help you differentiate between the two financial statements, you can ask yourself the following questions: 

• “What is our financial picture right now?” The balance sheet gives you this overview at a specific instance in time.

• “What is the financial picture of our company for the entirety of 2024?” The income statement will give you an overview, rather than just a snapshot. 

What is an income statement, and what do you use it for?

The income statement is sometimes referred to as the profit and loss (P&L) statement because its purpose is to track an organization’s revenue and expenses over a specific period. This gives you an overview of operational efficiency, department spending, and overall company performance that you can use to analyze how your company compares to another or find areas to cut costs. 

You typically prepare an income statement over key periods like quarters or at the end of a financial year. An income statement contains four key elements that allow you to find the net earnings (profit) of your company:

• Revenue: The money earned from the sale of products, fees earned from performing business services, interest from capital, lending, royalties, or other earnings. 

• Expenses: These include the cost of selling goods, administrative expenses, research costs, material costs, and wages that generated the operating revenue. Other expenses include things like interest paid on a loan. 

• Gains: Money earned from one-time sales, such as equipment, land, subsidiary company, or other long-term assets the company owns. 

• Losses: The opposite of gains—losses are one-time payments, such as lawsuits or the loss of long-term assets, that are not at the expense of operating revenue. 

All of these categories allow you to create the structure of the income statement, which is as follows:

Net Income = (Revenue + Gains) - (Expenses + Losses)

The final line of the income statement will tell you whether the company had a net profit or a net loss at the end of the given period.

Advantages of using an income statement in financial reporting

The income statement is an important piece of financial reporting that provides advantages such as helping to determine operational efficiency and comparing profitability with competitors. Discover more about the advantages of producing and analyzing an income statement are:

• Helping the top executives of a company see the overall revenue and operating expenses to determine their operational efficiency 

• Allowing investors to see the overall profitability of a company over a given period and potentially make predictions on future earnings

• Informing investors of their earnings per share (EPS) if the company were to distribute all of its net revenue from that accounting period

• Giving executives the ability to analyze and compare their profitability with that of competitors within the industry

The income statement is useful for executives, investors, and competitors to analyze a company's earnings over a specific period. 

Potential drawbacks of using an income statement in financial reporting

While the income statement can help you determine many things about your company, or one you want to invest in, you cannot solely rely on it as the perfect picture of financial health. The income statement does not provide an overview of the following key accounts:

• The current assets of the company, such as cash flow or other liquid investments.

• The liabilities a company has, such as money owed to vendors, wages owed, and debt, like loans.

• The equity of the owners, which includes paid-in capital, retained earnings, and equity owned by investors and stockholders.

These drawbacks of the income statement are offset by the balance sheet, which does cover the previously mentioned accounts and helps executives and investors create a clearer picture of financial health. 

Income statement vs. balance sheet vs. cash flow

The income statement measures the profitability of a company by tracking its revenue and expenses, while the balance sheet shows what a company owns in assets and equity, plus what it owes in liabilities. A cash flow statement, meanwhile, is the third core financial statement that shows how a company earns and uses its cash to pay for items. This shows how liquid a company truly is as they pay down debt, earn income, and pay expenses. 

What is a balance sheet, and what do you use it for?

The balance sheet is a financial statement that provides a time-specific snapshot of an organization’s assets, liabilities, and equity owned by shareholders. Companies use it to determine the amount of capital invested, what the company actually owns, and who the company owes money to. The balance sheet only shows the assets, liabilities, and equity at one particular point in time and does not illustrate an overall trend in itself. 

The balance sheet consists of:

• Assets: Everything the company actually owns, typically listed by liquidity. For example, cash in the bank would be first since it is the most liquid asset, then quickly converted assets, then equipment or long-term investments. 

• Liabilities: Everything a company owes money to, such as short-term debt, money owed to vendors, payroll, and taxes, as well as long-term debt like loans, pension funds, and interest payments. 

• Equity: Everything that business owners or shareholders have contributed or own, such as invested capital, retained earnings, and stock. 

The balance sheet follows what is known as the accounting equation:

Assets = Liabilities + Equity

Each part of the accounting equation gives investors and executives an idea of how much the company owns and how much it owes.

Should you do an income statement or a balance sheet first?

Generally, you should prepare your income statement first, as it allows you to see your total income and expenses of your business and whether you have a profit or loss over a specific period. After the income statement, many businesses produce a statement of retained earnings to track how much of the income went to equity payments like dividends. Utilizing information from the aforementioned statements, you can prepare your balance sheet to see exactly how much the company owns and who it owes money to. Finally, you can prepare the cash flow statement using numbers established from the previous three statements to see the outflow and inflow of money throughout the company.

Advantages of using a balance sheet in financial reporting

Balance sheets are an important financial report for both organization leaders and investors to determine a company’s value or net worth. Other advantages of preparing a balance sheet include:

• Determining the amount of risk in a company by showing the assets and liabilities, which helps you see the overall debt and how much cash you have available to pay that debt

• Showing potential investors or banks your company’s financial health and ability to repay debts as a way to raise capital 

• Investors and managers can analyze the numbers on a balance sheet to create financial ratios, such as debt-to-equity and quick ratios. These ratios help them find areas to improve financial health and compete with other companies

The balance sheet provides many different kinds of insights into a company’s debt, asset liquidity, and financial health. 

Potential drawbacks of using a balance sheet in financial reporting

Because a balance sheet focuses on a single point in time regarding your organization’s finances, it can limit your understanding of the company’s performance. Uncover more drawbacks that come with focusing solely on a balance sheet when analyzing a company:

• It limits your view to a single moment and prevents you from spotting financial trends or changes over time. For example, a company may have $10,000 on hand according to the balance sheet and plans to make a large investment later in the present month. However, the organization also needs to account for prior expenses in the income statement because it might be necessary to pay them in future with the $10,000.

• Different companies use different accounting methods. If you’re an investor analyzing a balance sheet, ensure that you familiarize yourself with how companies may present their financials in their efforts to highlight strengths and manage perceptions.

• One asset on a balance sheet is accounts receivable (AR), which is income a company expects to collect at a later date. However, this number may be deceiving, as some accounts may never pay. As you analyze a balance sheet, keep track of which accounts pay over time. 

Balance sheets provide an important snapshot of a company’s financial health, but relying on a balance sheet alone has some drawbacks. For instance, with some manipulation, a balance sheet can make a company in poor financial health appear more financially sound on paper.

Read more: What Is Bookkeeping? Tasks, Skills, and How to Become a Bookkeeper

Getting started with financial statements

By utilizing financial statements, you can gain key insights into your business, or a business you want to invest in. When you prepare financial statements correctly, they serve as powerful tools to evaluate business performance and guide sound financial decisions by presenting a picture of your company’s financial health.. 

Both the income statement and balance sheet show different financial data points for a company. Analyzing an income statement reveals a company’s profitability over a specific period. When paired with a balance sheet, you gain insight into its cash reserves, shareholder equity, and outstanding debts. 

When creating financial statements, you also have several software options to choose from such as Oracle NetSuite, FreshBooks, and Datarails.

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