What’s the Difference Between a P&L and a Balance Sheet?
Balance Sheets and P&L statements are two of the most common business financial statements. You likely pay more attention to P&L than the other; just generalizing, but such is the case with many business owners. Though many businesses ignore the balance sheet as it focuses on details other than income and expenses, it’s still a vital piece of intel.
But what’s the difference between balance sheets and P&L? Today, we’ll dive into the details and show you how to use them.
Profit and Loss Statements Decoded
A P&L statement, also known as an income statement, is helpful to assess your business’s profitability over a particular time period. P&L sheets tell you how profitable your business is, reporting on:
· Income
· Expenses
· Net profits or loss
· Cost of goods sold (COGS)
One of the main features of the P&L is that it’s a snapshot in time based on a period like a month, quarter, or fiscal year. It helps you understand how your budget compares to reality and reveals trends from one period to another. For example, you can compare the current year to the previous year or this quarter over the last. Understanding historical P&L trends helps you make better financial decisions and inform planning.
But though the P&L statement is super-useful and relatively easy to understand, it’s not the only tool in the box—and certainly not the only report you should be using to base your decisions on.
First, you should be comparing the P&L to your budget. This will clearly highlight areas that need adjustment or alert you when something is way out of whack. For example, when comparing budget to actuals, you might notice that your sales are lower than expected and you spent more on inventory or labor than you initially budgeted for. These details can significantly impact the bottom line—which, coincidently, is called the bottom line because it’s the last line in the P&L report, representing net income or profit.
P&L metrics
Here’s how the numbers on a P&L sheet break down:
· Gross profit = (net sales – cost of sales)
· Net operating profit = (gross profit – operating expenses)
· Net operating income = (revenue – operating expenses)
· Earnings before interest, taxes, depreciation, and amortization (EBITDA)
= net profit/loss + (interest + taxes + depreciation + amortization)
Understanding the Balance Sheet
The balance sheet is also a snapshot in time, but the details are quite different. While the P&L looks at financial performance over a time period, the balance sheet reveals the business’s finances on a specific date, including what you own, what you owe, and what’s been invested by your shareholders—in other words, your company’s assets, liabilities, and shareholder equity.
Balance sheets are useful for investors, analysts, and lenders when determining how effectively your company is managing its resources. Also relevant to this aspect is that it shows how your assets are financed, whether by a debt vehicle, like a loan or credit card or via equity, which will appear under shareholder equity.
Here are some examples of lines you’ll see on a balance sheet:
· Cash/cash equivalents: liquid assets, cash, and short-term investments.
· Marketable securities: equity and debt which can be liquidated.
· Accounts receivable: i.e., the money owed to you by customers.
· Inventory: the goods you offer for sale.
· Debt: long-term debt, bank loans, etc.
· Payables: wages and dividends you pay out.
· Taxes owed and deferred.
· Shareholder equity = total assets – total liability.
This is a significant metric used to determine a company’s financial health. It is the net value of the company if all company assets were liquidated and debts cleared, and what would be returned to the shareholders were that to occur.
So, you can think of your balance sheet as a financial health check. It shows your debt ratios and liquidity and provides critical information about how efficiently your company turns profits into cash. It quantifies your financial risk and allows you to identify areas that need adjustment or balance. Hence, it is often requested by lenders when applying for funding.
Differences Between Balance Sheets and P&L Statements
While both P&L and balance sheets are essential financial statements, it should be clear which report is most useful in any situation.
For example, you can’t calculate revenue from the balance sheet, so if you’re looking at the report and trying to figure out how much money you’re bringing in, you’re in the wrong place. However, it shows you how you earned or invested your money and how it has grown compared to two specific dates.
The bottom line on your balance sheet should always be zero. If it isn’t, you’ll need to find out why.
Details on the balance sheet include working capital, cash conversion cycle, and debt-to-equity ratio.
Even though the two statements are very different, you need both to understand the whole financial picture.
While the balance sheet is a container, the P&L is what fills it up. The container fills but also drains via expenses. As you can imagine, if the container drains completely, there’s nothing left. Hence, the overarching goal is always to keep the container full.
Here are a couple of examples of how one report informs the other.
· You have a large account receivable balance. There is a ton of money owed to you that you have not collected. The P&L shows the revenue (looks good!), but the balance sheet highlights that it’s outstanding (needs attention).
· You’ve purchased a lot of new equipment. Fixed assets would not show on the P&L. Since this is likely a huge cash outlay, the report may appear dismal. However, it shows as an asset on the balance sheet, which fills the gap and shows where your income is going.
· You’re holding a ton of inventory. Your P&L will not show this, but the balance sheet will report it as cash already spent. Further to that, the inventory method you choose will affect how it reflects on the balance sheet and the P&L.
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