A:

When you do research on different companies by looking at their annual reports, you will typically come across two separate financial statements: the balance sheet and the income statement (also known as the statement of profit and loss). These two statements are very significant for companies as they can be used to describe the company's health and effectiveness of management.

Balance Sheet - B/S
The balance sheet gives investors a general overview of a company's financial situation. That is, it tells investors exactly what a company owns (assets) and who it owes (liabilities).

Assets and liabilities are listed in order of liquidity (relative ease of convertibility to cash), from most liquid to least liquid. Assets appear on the left hand side of the balance sheet and liabilities on the right hand side. For simplicity's sake, think of a B/S as an indicator of net worth: that is, how much a company is worth "on the books."

Income Statement – I/S
The income statement tells investors about the company's profits and losses for a specific time period. Expenses are subtracted from income to determine a firm's profit or loss. Unlike the B/S, the I/S doesn't look at the company's financial health (total net worth). Instead, it looks at how much revenue a company is able to create. If you were to think of the B/S as an indicator of net worth, you can think of the I/S as a company's profitability: that is, how much it can make in a given time frame.

These two statements are intertwined and should be looked at by all people who are considering investing their hard earned money in a particular company. You should look at a company's B/S to see exactly how much it is worth (remember, this is a book value representation rather than market capitalization), and look at the I/S to see how profitable the company is. Obviously, if it has a negative net worth (its liabilities are greater than its assets) or if it has a negative income, then the company might not be the best place to invest your money.

RELATED FAQS
  1. What are some examples of general and administrative expenses?

    In accounting, general and administrative expenses represent the necessary costs to maintain a company's daily operations ... Read Full Answer >>
  2. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
  3. How often should a small business owner go through a bank reconciliation process?

    Small business owners should go through the bank reconciliation process at least monthly, and many business consultants recommend ... Read Full Answer >>
  4. What is the difference between recurring and non-recurring general and administrative ...

    The difference between recurring and nonrecurring general and administrative expenses can best be understood as the difference ... Read Full Answer >>
  5. How can I find net margin by looking a company's financial statements?

    In finance and accounting, financial statements represent the fundamental means of analyzing a company's financial position, ... Read Full Answer >>
  6. What can working capital turnover ratios tell a trader?

    A company's working capital turnover ratio is traditionally positively correlated with business performance. A high, or better ... Read Full Answer >>
Related Articles
  1. Term

    What are Non-GAAP Earnings?

    Non-GAAP earnings are a company’s earnings that are not reported according to Generally Accepted Accounting Principles.
  2. Credit & Loans

    What's a Nonperforming Loan?

    A nonperforming loan is any borrowed sum where the borrower has failed to pay scheduled payments for at least 90 days.
  3. Economics

    Understanding Cost of Revenue

    The cost of revenue is the total costs a business incurs to manufacture and deliver a product or service.
  4. Economics

    Understanding Cash and Cash Equivalents

    Cash and cash equivalents are items that are either physical currency or liquid investments that can be immediately converted into cash.
  5. Economics

    Explaining Carrying Cost of Inventory

    The carrying cost of inventory is the cost a business pays for holding goods in stock.
  6. Investing

    How To Calculate Minority Interest

    Minority interest calculations require the use of minority shareholders’ percentage ownership of a subsidiary, after controlling interest is acquired.
  7. Investing Basics

    3 Companies That Hate Debt Financing

    Learn how companies such as Chipotle, Bed Bath & Beyond, and Paychex are able to maintain impressive levels of growth without debt financing.
  8. Term

    What is Incremental Cost?

    Incremental cost is the added cost of manufacturing one more unit.
  9. Term

    What is Horizontal Analysis?

    Horizontal analysis compares a company’s balance sheet or income statement over two or more accounting periods.
  10. Stock Analysis

    How MetLife Became a Global Insurance Giant

    MetLife is the largest life insurer in the United States. Here's how it has managed to stay on top.
RELATED TERMS
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the ...
  2. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
  3. International Financial Reporting Standards - IFRS

    A set of international accounting standards stating how particular ...
  4. Revenue

    The amount of money that a company actually receives during a ...
  5. Balance Sheet

    A financial statement that summarizes a company's assets, liabilities ...
  6. Equity

    The value of an asset less the value of all liabilities on that ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!