The purpose of the income statement and balance sheet

Whether it is a global corporation listed on the stock exchange or it is a more modest one-owner firm, any type of business will have in common that they require the preparation and presentation of such basic financial statements.

With due knowledge of the elements of a balance sheet you will be able to know what your company invests funds in, what level of cash it handles, whether or not it has inventories, whether it maintains money in accounts receivable, its investment in fixed assets, how it is financed, what is your heritage.

The management of the income statement for its part, accounts for the operating income of the business, the gross profit, the operating result and the net income it generates.

Let’s dive into the purpose of the balance sheet and income statement.

The balance sheet

The balance sheet reports the assets, liabilities and equity of the company.

Assets are items owned by the company that you will use to generate profits. Its composition in percentage terms gives part of the economic position of the company, that is, in what the funds have been invested.

Liabilities represent money owed to third parties, individuals or companies, which will be used for accounts necessary for the operation of the business. They can be for short or long-term liabilities, depending on whether their maturity is less than or greater than one year respectively.

Capital or equity is the money of the shareholders or the owner’s investment in the company.

The purpose of the balance sheet

The purpose of the balance sheet is to report the company’s net worth, the difference between its total assets and liabilities, usually seen as the true value of a company.

The balance sheet represents the most important accounting report that must be issued at the end of each financial year and shows the assets, obligations and rights of the entity.

The objective of the balance sheet is simple: Synthesize where the company’s funds are invested (asset details) and reveal how they were obtained, that is, show the company’s financing channels (Liabilities + Equity).

The income statement

The income statement before so – called “profit and loss” reports all revenues, sales costs and expenses incurred by the business over a period of time.

It shows from sales income through gross and net income after expenses.

Companies need to track results to understand how much money they have made or lost in each period. Net profit or income refers to gross profit minus expenses.

The final difference indicates how much money a company has to pay the owners or to retain and use for reinvestment or future growth opportunities.

Purpose of the Income Statement

For the consultancy authorized by SAP, the income statement is essential as it allows to know how much the company is selling, how it is managing expenses and if it is generating profits or not.

A statement valued integrated with other financial statements of the period as the balance sheet and cash flow statement allows:

  • Measure the operational performance of the business.
  • Know in which part of the business or process the economic resources are being consumed.
  • Carry out a profitability analysis.
  • Know if the company is able or not to distribute dividends.
  • Create the input to evaluate cash flows.

Both the income statement and the balance sheet translate into nothing less than management support elements for decision-making and strategic planning.