Balance sheet vs. profit and loss statement: What’s the difference?

When looking at your financial statements, there are three main types that you will issue regularly: the balance sheet, the profit and loss (P&L) statement, and the cash flow statement. 

Of these three statements, people commonly confuse the balance sheet vs. the profit and loss statement. So what are the differences and similarities you should look out for, and how can each statement contribute to your company's financials?

What is a balance sheet?

Balance sheet example

What is a profit and loss statement?

Profit and loss statement example

When to use a balance sheet and profit and loss statement

Main balance sheet and P&L statement differences

Spend more time growing your business

Balance sheet vs profit and loss FAQ

How a balance sheet works 

A balance sheet is a financial statement that reports on a company’s assets, liabilities, and shareholders’ equity. It is used to gather information across a set financial reporting period—for example, on a monthly, quarterly, or yearly basis. 

The balance sheet is also known as the statement of financial position since it summarizes a business’s finances. This includes:

• The company’s total revenue since its inception
• Total acquired debt
• Comparison of assets and liabilities 

These elements provide a comprehensive overview of a company's financial structure. Let's explore each of them in more detail.

Assets

Assets can be thought of as what you own and can include property, equipment, or cash on hand. Basically, it’s anything that has value to your company. 

Types of assets:

• Cash and cash equivalents: This includes readily available cash on hand and short-term, highly liquid investments that can be easily converted to cash.
• Marketable securities: These are short-term investments that can be easily bought and sold in the market, such as stocks and bonds of other companies.
• Accounts receivable: This represents money owed to the company by its customers for goods or services already delivered or performed.
• Inventory: This includes raw materials, work-in-progress, and finished goods that a business holds for sale.
• Property, plant, and equipment (PP&E): This includes tangible assets like land, buildings, machinery, and equipment used in the company's operations.
• Long-term investments: These are investments held for longer than one year, such as investments in other companies (stocks or bonds), real estate held for investment, and other long-term financial instruments.
• Intangible assets: These are valuable, nonphysical assets like patents, trademarks, copyrights, and goodwill. 

Understanding these key asset types and how they are valued is essential for assessing a company's financial health and making informed business decisions. Now, let's turn our attention to the other side of the balance sheet: liabilities.

Liabilities

Also known as what you owe, liabilities can be represented by debt, accounts payable, or money owed to suppliers. Liabilities are something your company is liable to pay to someone else. 

Common types of liabilities:

• Accounts payable: These are short-term obligations to suppliers for goods or services received but not yet paid for.
• Salaries payable: This represents wages owed to employees for work performed but not yet paid.
• Short-term debt: This includes loans or other obligations due within one year. This might include lines of credit, short-term loans from banks, or the current portion of long-term debt.
• Long-term debt: This includes loans or other obligations due after one year. Mortgages, bonds payable, and long-term loans are examples of long-term debt.
• Deferred revenue: This represents payments received for goods or services that haven't been delivered or performed yet. It's a liability because the company owes the customer the goods or services.

Liabilities represent a company's obligations, and managing them effectively is crucial for financial health. Now, let's move on to the final component of the balance sheet: shareholders' equity.

Shareholders’ equity

This represents the residual value of a company's assets after all liabilities are paid. Essentially, it's what would be left for shareholders after liquidating the company, selling all assets sold, and settling all debts. Shareholders' equity is a key indicator of financial health, with a higher value generally suggesting a stronger financial position. 

It consists of common stock, which represents the capital raised from issuing ownership shares, and retained earnings, which are the accumulated profits the company has kept and reinvested rather than distributed as dividends. 

• Example:  Imagine a company with $1 million in assets and $400,000 in liabilities. Its shareholders' equity would be $600,000. This $600,000 could be made up of, say, $200,000 in common stock (the initial investment from shareholders) and $400,000 in retained earnings (profits accumulated over time).

Balance sheet example

To start you off on the right foot here’s a basic example of a balance sheet as well as a template to reference. The template includes a spreadsheet where you can tailor the rows and columns to your needs, such as adding new accounts and changing titles.

How a profit and loss statement works 

Profit and loss statements are another one of the three main financial statements. They include the summary of revenue, expenses, and total cost of production. The P&L statement offers insight into a company’s capacity to produce more revenue by either reducing costs or increasing sales prices.

A company’s P&L statement shows multiple factors of production over a set period of time—generally by month, quarter, or year, depending on your accounting structure.

Unlike a balance sheet, a profit and loss statement includes several more categories. 

Revenue

Revenue is the income generated from the company's primary business activities and typically includes sales of goods or services. It's important to distinguish between revenue and other income, such as interest earned or gains from investments.

Cost of goods sold (COGS)

Cost of goods sold (COGS) represents the direct costs associated with producing the goods sold by a company. This includes the cost of raw materials, direct labor, and manufacturing overhead. For service businesses, COGS might include the direct costs of providing the services.

Gross profit

Gross profit is calculated by subtracting the cost of goods sold from revenue. It represents the profit a company makes after covering the direct costs of producing its goods or services. It's a key indicator of the efficiency of the production process.

Operating expenses

Operating expenses are the costs associated with running the business, excluding the direct costs of production (COGS). These expenses are often categorized as follows:

• Selling expenses: These are costs directly related to selling the company's products or services. This includes salaries and commissions for sales staff, advertising and marketing expenses, shipping and delivery costs, and any other expenses directly tied to the sales process.
• Administrative expenses: These cover the general and administrative costs of running the business. This includes salaries for administrative staff, rent for office space, utilities, office supplies, legal and accounting fees, and other general overhead costs.
• Depreciation and amortization: Depreciation is the allocation of the cost of a tangible asset (like equipment or a building) over its useful life. Amortization is the same concept for intangible assets (like patents or copyrights). These expenses reflect the gradual decline in value of these assets over time.

Operating expenses are essential expenses for a company to function and generate revenue. 

Operating income

Operating income is calculated by subtracting operating expenses from gross profit. It represents the profit a company makes from its core business operations before considering interest and taxes. 

Interest expense

Interest expense is the cost of borrowing money. It includes interest paid on loans, bonds, and other debt obligations.

Income before taxes

Income before taxes is calculated by subtracting interest expense from operating income. It represents the company's profit before income taxes are deducted.

Income tax expense

Income tax expense is the amount of taxes a company owes to the government. It's calculated based on the income before taxes and the applicable tax rate.

Net income

Net income is the final profit or loss after all expenses, including taxes, have been deducted from revenue. It's often referred to as the "bottom line" and represents the company's overall profitability for the period. This net income then flows into the retained earnings portion of the balance sheet.

Profit and loss statement example

In the image below, we can see that all of the sales revenue, expenses, and taxes are listed, equalling the net income for the year. This will later coincide with the balance sheet you previously created in that the net income will appear in the retained earnings line item on the balance sheet.

When to use a balance sheet and profit and loss statement

A balance sheet and P&L statement can and should be used in different scenarios, depending on the financial period and the need to understand your company’s financial position. For example, here are a few instances in which a balance sheet and P&L are necessary:

• Closing of a financial period: The three financial statements, including the balance sheet and P&L, should be drawn up at the end of your financial period (every month or quarter), depending on when you close your books. 
• At the end of an operating cycle: Balance sheets and P&Ls are often prepared again at year-end or the end of a full operating cycle. 
• Investor inquiry: To get a full scope of your company’s financial situation, an investor will likely ask to see your balance sheet as well as your other financial statements.

Main balance sheet and P&L statement differences and similarities

However similar the balance sheet and P&L statement may seem, several key differences separate them, including:

• The order in which they are prepared
• The information they contain
• What they reveal about a company’s position
• When they are drawn up

The order in which they are prepared

The three financial statements work coherently together to create a fully holistic view of the company and its financial position. They have to be prepared in a particular order since the information from one affects the others. 

The order goes like this:

• The profit and loss statement: All income and expenses are added together to gather the net income, which you'll report as retained earnings. 
• The balance sheet: That net income becomes a retained earnings line item on the balance sheet, which is used to locate the ending cash balance.
• Cash flow statement: The cash balance from the balance sheet then appears on the cash flow statement.

This sequential relationship ensures accuracy and consistency across all financial reports. 

The information they contain 

As we mentioned earlier, the balance sheet and profit and loss statement yield very different information. One contains what belongs to the company, while the other shows how earnings were spent. The categories are broken out this way:

Balance sheet:

• Accounts payable
• Loans
• Variable debts
• Assets
• Dividends

The profit and loss statement:

• Admin expenses
• Cost of goods sold
• Research and development
• Total revenue

Examining the balance sheet and profit and loss statement will give stakeholders a comprehensive understanding of both the company's assets and liabilities, as well as its revenue generation and expense management. 

Insight into the company’s financial position

Say someone is interested in investing in your company and is curious about how the company is being run. A serious potential investor would likely ask to see your company’s financials to ensure the investment is a smart financial decision. Here’s what they’d gather from looking at each statement:

• Balance sheet: They could gather how company revenue has grown in the past as well as what assets the company currently possesses and what debt has been incurred. They could piece together your company’s financial position based on the liquidity of the business as it is. 
• Profit and loss statement: They could figure out your company’s ability to increase profits based on growth in sales as opposed to your cost of production. They could gauge your company’s overall financial performance.

Essentially, the balance sheet provides a snapshot of the company's financial health at a specific moment, while the profit and loss statement reveals its performance over a period of time. Together, these statements offer a comprehensive view of the company's financial viability and potential for future growth.

When the statements are created

Statement creation largely depends on your accounting period, as well as if you are seeking investors or creating a financial forecast to present. While these statements can both be drawn up at any time if your books are in the proper order, it’s more beneficial to wait until the end of a period for a full view. 

Traditional intervals for each statement:

• At the end of the accounting period (usually monthly or quarterly)
• At the end of the fiscal year
• When a company is being audited
• Consistent and timely preparation of these statements is crucial for effective financial management and reporting. 

Spend more time growing your business

Now that you have a firm understanding of the differences between the balance sheet and the profit and loss statement, what’s next? If you don’t have a strong accounting system in place already, forming these statements can prove to be a challenge. Using powerful accounting software like QuickBooks can lessen your burden on bookkeeping, creating your balance sheet, and locating your assets and liabilities.