How do the income statement and balance sheet differ?

Companies produce a set of financial statements that reflect their business activities and profitability for each accounting period. The three main financial statements are the balance sheet, income statement, and statement of cash flows. The cash flow statement shows how well a company is managing its cash to fund its operations and any expansion efforts. In this article, we'll examine the differences between the balance sheet and the income statement.

Balance Sheet

The balance sheet shows a company’s assets, liabilities, and shareholders' equity. Total assets should equal the total of liabilities and shareholders' equity. The balance sheet shows how a company puts its assets to work and how those assets are financed as listed in the liabilities section. Shareholders' equity is the difference between assets and liabilities or the money left over for shareholders if all debts were repaid. Investors and creditors analyze the balance sheet to see how a company's management is putting its resources to work.

To best analyze the key areas of the balance sheet and what they tell us as investors, we'll look at an example.

Apple Inc. (AAPL)

Below is Apple's balance sheet, as of the end of the fiscal year for 2017, from their annual 10K statement

Current Assets

The top section contains the current assets which are short-term assets that are typically used up in less than one year. 

  • Total current assets were 128.6 billion for the end of their fiscal year (highlighted in blue).
  • Cash totaled over $20 billion.
  • Marketable securities are short-term investments which totaled $54 billion. 
  • Accounts receivable, totaling $17.8 billion, is money owed to Apple for selling their products and services. A receivable could be due in 30, 60 or even 90 days depending on the terms of the agreement. Investors want to see receivables increase over time since it indicates increases in sales. However, we don't want to see aging receivables.
  • Inventories of $4.8 billion might be raw materials or supplies used in making their products or finished goods waiting to be sold or shipped. 

Long-term Assets

Next on the balance sheet are the long-term assets, such as:

  • Long-term investments totaled $194.7 billion  
  • Property, plant, and equipment totaled $33.7 billion and are called fixed assets because they're not consumed within one year and are used to generate revenue for the company over the long-term. 
  • Other assets and intangible assets, which include trademarks and intellectual capital round out the asset section.
  • Total assets for Apple was $375 billion for the end of their fiscal year in 2017.

Current Liabilities

Current liabilities are short-term liabilities for Apple that are due within one year and include: 

  • Current liabilities totaled $100 billion (highlighted in purple).  
  • Accounts payable were $49 billion and are short-term debt owed by Apple to its suppliers.  
  • Accrued expenses of $25.7 billion are expenses that have yet to be paid, but have a high probability of being paid.

Long-term Liabilities 

Not all of the long-term liabilities are broken out for Apple, but they typically include: 

Shareholders' equity

  • Retained earnings for Apple was $98 billion and is the money not paid out as dividends, but held by the company to be reinvested in its business, or to pay off debt.
  • Shareholders' equity is equal to a firm's total assets minus its total liabilities and is helpful in calculating the financial health of a company. Shareholders' equity represents the net value or net worth of a company which for Apple was $134 billion. Shareholders' equity is the money left over after paying off all liabilities such as debt in the event of liquidation and would be the amount returned to shareholders. 

Income Statement

The income statement, often called the profit and loss statement, shows the revenues, costs, and expenses over a period which is typically a fiscal quarter or a fiscal year. The income statement provides investors with whether a company is generating a profit or loss for the period. Also, the income statement provides valuable information about revenue, sales, and expenses for the company.

J.C. Penney Company Inc. (JCP)

Below is the income statement, as of the end of fiscal year for 2017, from J.C. Penney's annual 10K statement.

The top section includes total revenue or sales for the period.  

  • Net sales, also called revenue, was $12.5 billion for 2017. Revenue and sales are considered the top line for a company since they are located at the top of the income statement.
  • Cost of Goods Sold was $8.1 billion and represents the costs of producing goods and services during the period. COGS are direct costs and are only the expenses involved in the production process.
  • Selling, general, and administrative costs are the other expenditures not directly involved in production. For J.C. Penney, SG&A was $3.4 billion. 
  • Total costs or expenses were $12.39 billion for the year. 
  • Operating income was $116 million after subtracting total expenses from total revenues.
  • Net interest expense of $325 million represents the cost of debt servicing and puts J.C. Penney in the red for the year.
  • Net income for the year was a loss of 116 million. Net income is often referred to as net profit or the bottom line since it's the final number and is located at the bottom of the income statement.

J.C. Penney is a great example of the importance of looking at the complete financial picture. Although $12.5 billion in revenue appears on the surface to be an impressive number, when factoring in the cost of incurring debt, the company took a loss for the year. It's worth noting that comparing the financials of any company works best when compared over multiple periods and against companies within the same industry.  

Takeaways

The balance sheet displays what a company owns (assets) and owes (liabilities), as well as long-term investments. Investors scrutinize the balance sheet for indications of how effective a company's management is using its debt and assets to eventually generate revenue that gets carried over to the income statement.

The income statement shows the financial health of a company or whether or not a company is profitable. Both revenue and expenses are monitored closely since it's crucial for management to grow revenue while keeping costs under control. For example, a company's revenue might be growing, but if expenses are rising faster than revenue, the company may eventually incur a loss. Typically, investors and analysts pay close attention to the operating section of the income statement to gauge how efficiently management operates the company.

However, it's safe to say that both statements are scrutinized by investors and analysts since they provide a strong indication of the current health and future prospects of any company.