Financial statements are statements issued by large listed companies that show a formal record of financial activities of the business. Statement of financial position, statement of profit and loss, statement of cash flows, statement of changes in equity and disclosure notes to the accounts are some of the types of financial statements.
This article looks at meanings of and difference between two important financial statements – statement of profit and loss and statement of financial position.
Definitions and explanations:
Statement of profit or loss:
Statement of profit or loss is a financial statement which summarizes all the revenues, costs and expenses incurred during a relevant financial year. This financial year can vary for different companies. This statement is also called as income statement. The basic equation for an income statement is:
Sales – expenses = profit/(loss)
Statement of financial position:
Statement of financial position is a financial statement which shows the amount of owned assets, owed liabilities and the net capital (difference of assets and liabilities) of a business. It is also called as balance sheet. The basic equation for a balance sheet is:
Assets – liabilities = capital
Difference between statement of profit and loss and statement of financial position:
The major points of difference between statement of profit and loss and statement of financial position are given below:
1. Information disclosure:
A balance sheet is a list of all the assets and liabilities of a company. The difference of these assets and liabilities is the equity/capital of the owners/shareholders of the company. Balance sheet discloses the valuation of these line items at a certain point of time, while a statement of profit or loss shows the revenues earned and expenses paid by a business for a specific period of time.
2. Accounts for preparation:
The T-accounts (also termed as ledger accounts) maintained for the preparation of income statement are made nil at the end of each financial year. This is because the revenues have been earned and the related costs and expenses are already incurred. However, the T-accounts maintained for the preparation of balance sheet are carried forward from prior year to the following year. The reason being these assets, liabilities and capital are on-going and still present at the time of preparation of the statement and do not just belong to a specific financial year.
The main users of all financial statements are the shareholders, but these statements are also used by other stakeholders to extract relevant information. Statement of financial position and statement of profit or loss show different perspectives about the financial health of the business. The balance sheet shows that how well the management of a company is utilizing its assets and debt capacity to sustain a going concern business which can generate profits and carry out its business activities in the near future (normally 12 months). The income statement shows the profitability of the business and whether a business is earning operating income or not.
4. Scope of information:
Balance sheet reveals more information about the financial aspects of a business as it includes detailed information about the assets, liabilities and capital of a business. These components are pivotal in understanding the profitability and liquidity status of any business. Although, the scope of income statement is not limited, it shows the main sources of income and major expenses that company incurs to earn revenues. It also shows any other income (if any) which is generated through other than normal course of business.
Both financial statements are vital and mandatory by law for listed companies to publish annually. These statements are prepared and published for the respective financial years of a company. The management of a company needs to undertake both the financial statements into consideration in order to grow income and cut costs. Other stakeholders like potential investors, creditors, banks, tax authorities etc. scrutinize these statements before making any decision related to the company. However, these mere financial statements hold little value or confidence of any stakeholder unless these are audited by an independent firm which provides an audit opinion about the truth and fairness of these reports. Now-a-days, governments especially money laundering regulatory authorities use and analyze financial statements and their audit reports as trails for the business activities of companies.