Income Statement vs Balance Sheet – Income statement and balance sheet are two of the most important financial statements investors should check out. In this article, we will have a look at both of these and we will also know how these both are connected.
Let’s have a glance at the sequence of the article.
In this article, we will talk about the following –
- Income Statement vs Balance Sheet
- Income Statement vs Balance Sheet – Key Comparisons
- Income Statement vs Balance Sheet Format
- Balance Sheet Vs Income Statement – Colgate
Income Statement vs Balance Sheet
There are four statements that are usually treated with reverence.
Balance sheet can’t exist without having an income statement. If a company has a balance sheet, it must have an income statement where you can reach the “bottom line” (net profit).
So, let’s have a look at the income statement vs balance sheet together and then we will talk about how we can connect them.
What is Income Statement?
As an investor, you can have a complete picture of a company by simply looking at an income statement. Income statement helps you reach the “bottom line” which is most important to a company.
Here’s a glimpse of what an income statement is –
- Income statement is a simple statement which takes all income and expenses into account and ascertains a “net” balance justifying the two. If incomes are more than expenses, we will get “net profit”. And if the incomes are less than expenses, we will incur “net loss”.
- As per U.S. SEC (U.S. Securities & Exchange Commission), income statement is just like stairs. As an investor, you need to look step by step. Also, have a look at Types of SEC Filings
- The final computation at the end of the statement will give you the “bottom line”. That means “bottom line” is either “net profit” or “net loss”.
What is Balance Sheet?
Balance sheet will help you understand a holistic picture of a company’s financial matters. It is prepared once the income statement is set up. Let’s have a look at what balance sheet is all about.
- The balance sheet provides information about three things – assets, liabilities and shareholders’ equity.
The most important equation of balance sheet is –
Assets = Liabilities + Shareholders’ Equity
- Assets are arranged on the left side of the balance sheet. And liabilities and shareholders’ equity are written on the right. But quite often, companies use a top-down approach in setting up the balance sheet. The assets are written first and then the liabilities and shareholders’ equity are being written.
- The balance sheet is very straight-forward and if you can look at the income statement and balance sheet together, you would see that balance sheet is less complex than the income statement.
How do we connect income statement and balance sheet?
After ascertaining the “net profit” for the period from the income statement, the company decides how much to pay off as dividends and how much they would plow back as retained earnings. The amount which is left aside as retained earnings will come in the balance sheet under “shareholders’ equity”.
In the beginning of existence, very few company pays dividends as they want to reinvest the whole amount to business. That’s why in most cases the entire net profit is considered as retained earnings after paying the amount of debt (if any).
Income Statement vs Balance Sheet – Key Comparisons
|Items||Income Statement||Balance Sheet|
|What is it?||The Income Statement shows how the business has performed for the period of time under consideration||Balance Sheet provides us an overall picture of the company’s financials. It provides details on sources of Funds and Uses of Funds.|
|Key Items?||Revenue – Revenue results from entity’s operating activities (selling merchandise, selling services)
Costs and Expenses – These are incurred in generating revenues and operating the entity
Profit – The net balance is the Profit that the business makes
|Assets – Assets are firm’s economic resources. They are the current and future economic benefits obtained or controlled by an entity as a result of past transaction or events. Assets are further divided into two types – Current Assets and Long Term Assets.
Liabilities – Liabilities are obligations owned to others as of the balance sheet date. They arise from present obligations of a particular entity to transfer assets or provide services to other entities in future as a result of past transaction or events.
Shareholder’s Equity – The third section of a balance sheet is Stockholders’ Equity. (If the company is a sole proprietorship, it is referred to as Owner’s Equity.) The amount of Stockholders’ Equity is exactly the difference between the asset amounts and the liability amounts.
|Time Period||Income Statement is prepared for a period of time. For example, Colgate in its 10K Filings reports income statement for the period between 1st January to 31st December.||Balance Sheet, on the other hand, is at a specific point in time. Colgate reports its balance sheet as of 31st December.|
|Financial Analysis||Gross margin, Operating Margin, Net Margin, Operating Leverage, Financial Leverage, ROE (uses Equity from Balance Sheet)||Current Ratio, Quick Ratio, Cash Ratio, Receivables Turnover Ratio, Inventory Turnover Ratio, Payables Turnover Ratio, DSCR Ratio, Return on Total Assets|
|Uses||Income Statement helps the Management by providing them with an overall view of the business. Revenue vs Costs, how profitable the business is and areas that they should focus on||Balance Sheet provides the management with an overall financial health of the company – amount of debt taken, total liquidity position of the company, cash and cash balance etc|
Income Statement vs Balance Sheet Format
Let’s have a look at the format of Income Statement vs Balance Sheet now.
We will explain how the items are being arranged in both income statement and balance sheet and then we will look at a pictorial representation of them.
Format of Income Statement
- First, we will start with “total sales/ revenue”. Total revenue can be calculated by multiplying the total units produced with price per unit. This is called “gross revenue”. From gross revenue, sales returns/sales discount is being deducted which gives us “net revenue”.
- After that, we will include “cost of sales” which are the cost directly related to sales. After deducting the “cost of sales” from the “net revenue”, we will get “gross profit/ loss”.
- From “gross profit/ loss”, operating expenses (selling & administrative expenses, salaries of personnel, research & development expenses etc.) would be deducted. Operating expenses are expenses which are not directly related to sales. Then, we will also deduct the depreciation from the gross profit/ loss. Deducting operating expenses and depreciation expenses from gross profit/ loss would give us operating profit or EBIT (Earnings/ Loss before interest and taxes).
- Now there are two things that need to be done. First, the interest expenses need to be deducted from the EBIT and second, the interest income earned from the “savings account” of the company would be added back. And we will get PBT (Profit/ Loss before taxes).
- Finally, we will deduct the taxes to reach to the bottom line. It can be either “net profit” or “net loss” which is also called “profit/ loss after tax”.
- After that, we need to calculate the EPS. For example, if we need to compute the EPS of Company MNC and we know that the “net profit” is $500,000 and the number of “outstanding shares” is 50,000; the EPS would be = ($500,000/50,000) = $10 per share.
Let’s have a glance at the pictorial representation of the income statement format –
Income Statement of ABC Company as at 31st December, 2015 & 2016
|Details||2016 (In US $)||2015 (In US $)|
|Gross Sales (Revenue)||30,00,000||28,00,000|
|(-) Sales Returns||(50,000)||(30,000)|
|(-) Cost of Goods Sold (COGS)||(21,00,000)||(20,00,000)|
|Total Operating Expenses||(400,000)||(350,000)|
|Operating Income (EBIT)||450,000||420,000|
|Profit before Income Tax (PBT)||400,000||370,000|
|Net Income (PAT)||275,000||270,000|
|Earnings Per Share (EPS)*||$27.50/share||$30/share|
*Note: The numbers of outstanding shares for the year end 2015 & 2016 are 90,000 and 100,000 respectively.
Format of Balance Sheet
Let’s have a glance at the format of the balance sheet.
- First, we will write the assets as per the liquidity. That means we will first put down the “current assets”. Current Assets include – Cash & Cash Equivalents, Short-term investments, Inventories, Trade & Other Receivables, Prepayments & Accrued Income, Derivative Assets, Current Income Tax Assets, Assets Held for Sale etc.
|X (in US $)||Y (in US $)|
|Total Current Assets||12500||14500|
- After current assets, we will write down “non-current assets” which can’t be converted into cash within a year. Non-current assets include – Property, plant and equipment, Goodwill, Intangible assets, Investments in associates & joint ventures, Financial assets, Employee benefits assets, Deferred tax assets etc.
- The total of current assets and non-current assets will be called “total assets”.
- After total assets, we will include “current liabilities”. Under current liabilities, we will include – Financial Debt (Short term), Trade and other payables, Accruals and deferred income, Provisions, Derivative liabilities, Current Income Tax Liabilities, Liabilities directly associated with assets held for sale, accounts payable, sales taxes payable, income taxes payable, interest payable, bank overdrafts, payroll taxes payable, customer deposits in advance, accrued expenses, short-term loans, current maturities of long-term debt etc.
|X (in US $)||Y (in US $)|
|Current Taxes Payable||5000||6000|
|Current Long-term Liabilities||11000||9000|
|Total Current Liabilities||20000||18000|
- After current liabilities, we will include “non-current liabilities”. Non-current liabilities include – Financial Debt (Long term), Employee Benefits Liabilities, Provisions, Deferred Tax Liabilities, Other Payables etc.
- The total of current liabilities and non-current liabilities will be called “total liabilities”.
- Finally, we will include the last – “shareholders’ equity”. Here’s how we will format shareholders’ equity –
|Additional Paid-up Capital:|
|(-) Treasury Shares||(**)|
|(-) Translation Reserve||(**)|
Balance Sheet Vs Income Statement – Colgate
For interpreting the Balance Sheet vs Income Statement, we make use of Vertical Analysis or Common Size Statement.
- For each year, Income Statement line items are divided by its respective year’s Top Line (Net Sales) number.
- For example, for Gross Profit, it is Gross Profit / Net Sales. Likewise for other numbers
Interpretation of Colgate’s Income Statement
- In Colgate, we note that gross profit margin (Gross Profit / Net Sales) has been in the range of 56%-59%.
- We also note that the Selling General and administrative expenses (SG&A) has decreased from 36.1% in 2007 to 34.1% in the year ending 2015.
- We note that Net profit Margin has been in the range of 12% to 14.5%. However, it decreased in 2015 to 8.6%
- Also, note that the operating income has dropped significantly in 2015.
- Also, effective tax rates jumped to 44% in 2015 (from 2008 until 2014, it was in the range of 32-33%).
Interpretation of Colgate’s Balance Sheet
- For each year, Balance Sheet line items are divided by its respective year’s Top Assets (or Total Liabilities) number.
- For example, for Accounts Receivables, we calculate as Receivables / Total Assets. Likewise for other balance sheet items
- Cash and Cash equivalents have increased from 4.2% in 2007 and is currently standing at 8.1% of the total assets.
- Receivables have decreased from 16.6% in 2007 to 11.9% in 2015.
- Inventories have decreased too from 11.6% to 9.9% overall.
- What is included in “other current assets”? It shows a steady increase from 3.3% to 6.7% of the total assets over the last 9 years.
- On the liabilities side, there can be many observations we can highlight. Accounts payable decreased continuously over the past 9 years and currently stands at 9.3% of the total assets.
- There has been a significant jump in the Long-Term Debt to 52,4% in 2015.
- Non-controlling interests has also increased over the period of 9 years and is now at 2.1%
- Finance for Non-Finance Managers Training
- Free Financial Modeling Training (Colgate Excel Model)
- Ratio Analysis
Income statement vs balance sheet, they go hand in hand. And if we only look at the income statement, we would miss out on the holistic picture of the financial matters of the company. And if we only concentrate only balance sheet, we will not have a clue about the bottom line.
So, you need to know how to look at both at the same time. As an investor, these two statements will help you compute most of the ratios. These ratios will help you ascertain a clear picture of the company and then you can decide whether you should invest into the company or not.