By Indeed Editorial Team
Published June 8, 2021
Balance sheets and profit and loss statements are both financial documents. Companies and accountants can use these statements to assess the financial health of an organization. If you want to be a financial professional or manage company finances, you may want to learn more about the uses of both balance sheets and profit and loss statements. In this article, we cover what a balance sheet is, what a profit and loss statement is, the difference between them and when to use each.
Related: Everything You Need To Know About Financial Accounting
What is a balance sheet?
A balance sheet is a financial document that tracks an organization's shareholders, debt and assets. Balance sheets are useful for determining the overall health of company growth and operations. A balance sheet represents a business's financial situation for a specific date. Because balance sheets are specific, financial experts can't use them for broad overviews of a company's financial situation. Many accountants use balance sheets to determine financial ratios, like debt-to-equity, that allow them to understand the organization's financial health.
Companies and financial experts choose to format their balance sheets differently and include varying details. For example, some businesses may choose to include long-term liabilities, while others may not. These are some aspects that may be on a balance sheet:
- Accounts payable: These are payments that a company may owe to someone else for products or services.
- Accounts receivable: This is money that the company is expecting from a client or customer.
- Bank or other loans: Loans are liabilities that may be through varying financial institutions or individuals.
- Cash and equivalents: An organization's most liquid assets are its cash and equivalent assets.
- Company inventory: If the business sells physical products, it can include inventory as assets.
- Fixed-type assets: These assets include owned objects or materials like equipment, structures and property.
- Intangible assets: Though these assets are not physical objects, they may include patents, logos or intellectual property.
- Long-term investments: Long-term investments are assets that the company can't liquidate in a year's time.
- Marketable securities: An organization may include assets for which there are liquid markets.
- Prepaid expenses: Contracts, equipment or building rental and licenses are all pre-paid expenses.
- Wages and dividends: The organization may need to pay out dividends or wages to employees.
Related: How To Create a Balance Sheet (With Examples and Tips)
What is a profit and loss statement?
Profit and loss statements are financial documents that track a company's costs, expenses and revenues for a business term. A profit and loss statement typically includes information quarterly or annually. The profit and loss statement can allow a financial team to determine if a company needs to increase revenue or reduce cost in order to remain financially healthy.
Profit and loss statements help financial experts determine if the company or organization is profitable, and because of that some institutions, like non-profits, may use other formats. These are some aspects that profit and loss statements usually include:
- Administrative expenses: These are expenses related to the administration or management of an organization, including wages and hiring costs.
- Cash dividends per common share: These are the cash dividends a company issues for every outstanding common share.
- Costs of total goods sold: This refers to the expense of producing the products sold by the business. It includes labor and materials used to create goods.
- Development and research costs: These are expenses related to creating new products or researching advancements.
- Interest and selling expenses: A company may include all expenses related to interest paid and selling costs.
- Total revenues and sales: The amount of money that a business earns within the quarter or year is one of the most important aspects included in a profit and loss statement.
Related: Profit and Loss Template: Definition and Sample
Balance sheet vs. profit and loss statement
These are some of the key differences between balance sheets and profit and loss statements:
When experts prepare them
A key difference between these two documents is that financial experts typically prepare them at different points in the business cycle. Financial professionals typically create the balance sheet on the last day of a financial year. They prepare the profit and loss statement while considering the upcoming financial year.
The information they include
You can use the information included in the document to determine if it is a balance sheet or a profit and loss statement. Balance sheets usually include more broad information like accounts payable, loans, cash, inventory, assets, investments, securities, expenses and dividends. A profit and loss statement usually shows administrative expenses, dividends per common share, cost of goods sold, research costs and total revenue and sales.
What order to create them in
Balance sheets and profit and loss statements are two of the three financial documents that most accountants use when preparing a financial report for their company. Because the statements all work together to provide a comprehensive view of the company's financial health, you prepare them in order. The profit and loss statement comes before the balance sheet in chronological order.
Related: Managerial Accounting vs. Financial Accounting: Definitions and Differences
When to use each statement
These are some situations and which type of financial statement is best for each:
Assess more financial information
When a financial expert wants to assess more financial information, they may choose to use a balance sheet. Balance sheets are broadly prepared compared to profit and loss statements. A balance sheet shows what a company owes, its long-term investments and its assets, while a profit and loss statement does not show these things.
Compare financial health from two dates
Balance sheets show financial information from a specific date rather than over a period of time, as a profit and loss statement does. Financial experts may want to see how a company has improved or worsened in financial health by comparing figures from varying dates. Because balance sheets focus on balances from specific dates, they're best for this.
Determine if the company is profitable
The purpose of a profit and loss statement is for experts to determine if a company is profitable. By examining the top and bottom lines of a company, financial professionals can determine if the company has been or may continue to be profitable. Depending on the results of this determination, they may offer suggestions for how to improve the financial health or profitability of the company.
Related: What Is Profit and Why Is It Important?
Measure financial transaction accuracy
Accurate transaction records are important to good accounting. When you want to determine the accuracy of your financial transaction records, you can use a profit and loss statement. Investors may want to see that a company can keep factual records.
Monitor cost and expense efficiency
To understand if a company is making efficient choices in costs and expenses, you may use a profit and loss statement. Examining the profit and loss statement allows financial experts to determine if each cost and expense is producing an increase in revenue. If not, they may begin offering solutions for lowering costs.