Both balance sheet and profit and loss are important financial statements mostly used for keeping accounts. It is used mostly by business owners. It includes assets, equity for shareholders, and liabilities.
Define balance sheet
A balance sheet is a statement used mainly for financial modeling and accounting. It is used to show how a company’s total assets are to be financed. This is done either through debt or equity.
A balance sheet is also called a statement of net worth, and sometimes, it can be referred to as a statement of financial position. A balance sheet is composed of assets, liability, and equity. It is usually prepared towards the end of a company’s reporting period. It could be monthly, quarterly, or annually.
Purpose of a balanced sheet
The main purpose of a balance sheet is to reflect every transaction made by your company. It gives you a pictorial view of your company’s financial health. There are several reasons why your company needs to use a balance sheet. Some of which includes:
- It can be used to get the full picture of what your company looks like. This is made easy with the help of other statements like the cash flow statement and income statement.
- It helps you know how much money your company has, your company’s net worth, and where it is kept.
- It is used to get investors and secure a loan or even to sell your business.
- It helps you to see your company’s financial account for every particular transaction.
- It helps you know your business assets, liabilities, and equity. That is, what your business owns, what it owes, and what remains. It helps you know how much money you have invested into your business and how much debt has been made.
Define profit and loss
A profit and loss statement is a financial report that summarizes the costs and expenses a company earns for a specific period. It is most times referred to as P&L or a profit and loss account. A profit and loss statement is usually used to give business owners an overview of their companies income over a particular period to know if their business is currently at a profit or loss. It is usually one month over a year.
A profit and loss statement is one of the best documents on finances every company should have. It is useful for managing your company’s income. The profit and loss account gives our company operating costs, e, and earnings. This is achieved by comparing your profit and loss accounts across various time frames.
The profits seen in the profit and loss account are used to calculate the income and corporation tax. It is important to get your profit and loss account right to avoid paying added interest and penalties. Profit and loss accounts also record all expenses these revenues cause, which includes tasks etc.
P&L is obtained first from getting the profit received from selling assets. This is the operating profit. This operating profit is added to the operating income and lessened from the operating expenses. This results in either a net profit or a net loss. It is known to be a net profit if the operating income exceeds the operating expenses. It is known to be a net loss if the operating expenses exceed the operating income.
Importance Of Profit And Loss
The main aim of a business is to get profit. The success of any business entity is dependent on how much profit has been made. For upcoming businesses, it is important to calculate the profit to ensure clarity in transactions. The importance of having an accurate profit and loss account includes:
- To build and increase your business.
- To create room for more investment.
- To create employment opportunities by bringing in pre-staff.
Differences Between A Balance Sheet And Profit And Loss Account
A profit and loss account and a balance sheet are important documents to be used in a financial statement. They are used to report financial statements for the understanding of readers. Therefore, for readers to fully understand their functions, they need to know the differences between both. These differences include:
- While a balanced sheet is used to show what your business owns, what it owes, and what is left from the business transaction, the profit and loss account is used to show the company’s expenses used in a particular time frame.
- The balance sheet is made and presented between a particular period, while the profit and loss account is prepared ahead to be used for a particular period.
- The balance sheet is first prepared before a profit and loss account. The details of the balance sheet usually are transferred to the profit and loss account.
- The balance sheet is preferably seen to be more of a statement than a profit and loss. The profit and loss are more of an account.
- A balance sheet is used to give the company a pictorial view of its financial health to know where it stands. Profit and loss accounts, however, show the performance of the company financially.
- Unlike the profit and loss account, a balance sheet does not show the daily transactions. It only summarises the income, sales, and expenditure that may lead to profit or loss for a given period.
- A balance sheet represents your company’s financial position at a particular time, which includes the assets, liability, and equity.
The balance sheet and profit and loss account each have their significant characteristics. It is therefore easy to identify them. This can be used to show investors and other interested parties whether or not the company made money during the period being reported.
Most people prefer to study their profit and loss account more than their balance sheet because they believe it provides the most important details. However, while you look forward to each profit and loss account of your business which is usually monthly or yearly, you need to understand the continuous profitability of a balanced sheet.
A balance sheet helps you know from the start of your business the profit and losses that have been incurred. This is done to earn business owners of the dangers ahead further. The balance sheet helps answer questions like:
Is the company moving at a profit or loss?
Is the company able to pay up future debt?
Is the company spending on things not needed?
Is the company going bankrupt?