Income Statement and Balance Sheet Differences
Income statement is one of the financial statements of the company which provides the summary of all the revenues and the expenses over the time period in order to ascertain the profit or loss of the company, whereas, balance sheet is one of the financial statements of the company which presents the shareholders’ equity, liabilities and the assets of the company at a particular point of time.
Income Statement provides how the company’s business performance has been during the given period, whereas the balance sheet is a snapshot of the company’s assets and liabilities at a given point in time.
Income Statement vs. Balance Sheet Format
We will explain how the items are being arranged in both income statements and balance sheets, 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 the 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 that 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 earnedThe Interest Income EarnedInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. 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 the bottom lineThe Taxes To Reach The Bottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its 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 calculate 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 income statement formatIncome Statement FormatThe standard format for preparing a company's income statement starts with the sales revenue figure of the business and then adds other income to it. After deducting all business expenses from the total amount of revenue and other income generated, the net profit/loss of the business organization is determined. –
Note: The numbers of outstanding sharesNumbers Of Outstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet. 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.
- 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 assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. , Investments in associates & joint ventures, Financial assets, Employee benefits assets, Deferred tax assets, etc.
- The total of current assets and non-current assetsNon-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark. 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 payableSales Taxes PayableSales taxes payable refers to the liability account created when an entity collects sales taxes on behalf of the government and stores the aggregate amount of taxes before paying the concerned taxes authority., income taxes payable, interest payableInterest PayableInterest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company's balance sheet., bank overdrafts, payroll taxes payable, customer deposits in advance, accrued expenses, short-term loans, current maturities of long-term debt, etc.
- 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 –
Colgate Example to Differentiate
For interpreting the Income Statement and Balance Sheet, 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 SalesNet SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales.) number.
- For example, for Gross ProfitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services., it is Gross Profit / Net Sales. Likewise for other numbers
Interpretation of Colgate’s Income Statement
- In Colgate, we note that the profit marginProfit MarginProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. (Gross Profit / Net Sales) has been in the range of 56%-59%.
- We also note that SG&A has decreased from 36.1% in 2007 to 34.1% in the year ending 2015.
- We note that Net profit MarginNet Profit MarginNet profit margin is the percentage of net income a company derives from its net sales. It indicates the organization's overall profitability after incurring its interest and tax expenses. has been in the range of 12% to 14.5%. However, it decreased in 2015 to 8.6%
- Also, note that the operating income dropped significantly in 2015.
- Also, effective tax ratesEffective Tax RatesEffective tax rate determines the average taxation rate for a corporation or an individual. For both, there is a similar formula only with variation in considering variables. The effective tax rate formula for corporation = Total tax expense / EBT 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 ReceivablesAccounts ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet., we calculate as Receivables / Total Assets. Likewise for other balance sheet items
- Cash and Cash equivalents have increased from 4.2% in 2007 and are currently standing at 8.1% of the total assets.
- Receivables had 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 assetsTotal AssetsTotal Assets is the sum of a company's current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equity.
- There has been a significant jump in the Long-Term Debt to 52,4% in 2015.
- Non-controlling interestsNon-controlling InterestsIt generally projects curves on the data sets. For example, to forecast population growth, forming a non-linear relationship between time and growth. have also increased over the period of 9 years and are now at 2.1%
Balance sheet vs. Income Statement, 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. If we only concentrate on the 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 calculate 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 in the company or not.
Income Statement vs. Balance Sheet Video
This has been a guide to Income Statement vs. Balance Sheet with a step by step comparison. Here we also took practical examples of Colgate to highlight the differences between the financial Statement. You may also have a look at the following articles –