How are a company's financial statements connected?

By Investopedia Staff AAA
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 the generally accepted accounting principles for inventory reserves?

    As with most matters related to generally accepted accounting principles (GAAP), accountants assigned with the task of applying ...
  2. Why do some companies pay a dividend, while other companies do not?

    Dividends are corporate earnings that companies pass on to their shareholders. There are a number of reasons why a corporation ...
  3. What are some of the key differences between IFRS and U.S. GAAP?

    The International Financial Reporting Standards (IFRS) - the accounting standard used in more than 110 countries - has some ...
  4. Which transactions affect the retained earnings statement?

    Retained earnings are the portion of a company's income that management retains for internal operations instead of paying ...
RELATED TERMS
  1. Working Capital

    This ratio indicates whether a company has enough short term ...
  2. Price-To-Cash-Flow Ratio

    The ratio of a stock’s price to its cash flow per share. The ...
  3. Retention Ratio

    The proportion of earnings kept back in the business as retained ...
  4. Ratio Analysis

    Quantitative analysis of information contained in a company’s ...
  5. Accumulated Other Comprehensive Income

    Expenses, gains, and losses reported in the stockholder’s equity ...
  6. Contra Account

    An account found in an account ledger that is used to reduce ...
comments powered by Disqus
Related Articles
  1. Material Adverse Effect A Warning Sign ...
    Markets

    Material Adverse Effect A Warning Sign ...

  2. SEC Filings: Forms You Need To Know
    Investing Basics

    SEC Filings: Forms You Need To Know

  3. Footnotes: Early Warning Signs For Investors
    Retirement

    Footnotes: Early Warning Signs For Investors

  4. How To Decode A Company's Earnings Reports
    Fundamental Analysis

    How To Decode A Company's Earnings Reports

  5. An Introduction To Depreciation
    Active Trading

    An Introduction To Depreciation

Trading Center