The balance sheet and profit & loss (P&L) account provide important records of your company’s finances. Both contain similar financial information but there are key differences between the two and each one offers a distinct overview of your company’s finances. In this article, we look at what these fundamental accounting documents mean in practice.
The balance sheet provides a snapshot of what a business owes and owns in terms of assets and liabilities. It also includes details of shareholders’ equity and the amount currently invested by one or more individuals. The balance sheet shows how assets are being financed (through share of equity or as debt under liabilities) and can tell potential investors and creditors how efficiently the company is using its resources.
Current assets include cash, money owed to the business by clients, equity, debt securities and inventory which includes goods or items you have for sale. Non-current or tangible assets include equipment, machinery and property. Goodwill, copyright and patents can also be non-current assets. Liabilities are debts, including any long-term debts to the bank etc., wages, rent, tax, utilities’ bills, and dividends payable.
Shareholders’ equity represents the company’s assets minus its liabilities and shows the net value of the company at a glance. As such, it’s an important financial metric and reveals the amount that would be returned to shareholders if the company’s assets were to be liquidated and all its debts repaid. Retained earnings, which are those earnings not paid out as dividends but used to pay off debt or reinvest in the business, also comes under shareholders’ equity.
What’s a trial balance sheet?
The balance sheet is not to be confused with a trial balance sheet as the latter is a report that contains more general ledger information. This will be used to prepare the balance sheet eventually but trial balance sheets typically stay within the accounting department (or accounting software!) and are not distributed to investors or anyone else for that matter.
The P&L account or statement (also known as an income statement) summarises the trading results for a company over a specific period such as a fiscal quarter or, more typically in the case of SMEs, for the whole year. Revenue, expenses incurred and outgoings or costs for the period will all be shown in the P&L account and reveals the company’s profits or losses for that period. Income not generated through trading, such as grants or bank loans are not generally included on P&L accounts but they will have to be reported in the balance sheet.
What’s the difference between balance sheet and P&L account?
The balance sheet tells you how much the company is worth in terms of its total value at a specific point in time. It gives a broader view of the company’s finances overall by showing what the business owes and owns and also includes the full value of any long-term investments – something the P&L account does not. Simply put, the balance sheet takes everything into account before describing what the company is actually worth at any given point.
The P&L account shows whether or not the company has operated at a profit or a loss during a fiscal period and is used by the company to see the bottom line or profit, once the costs of doing business are subtracted from the top line, or revenue. By comparing revenue generated against costs and expenses over a fiscal period, it should be easier to see where the business can grow profits by cutting costs, for example, or by boosting sales.
P&L accounts allow for more careful monitoring of the financial health of the company as it highlights where revenue is strong but also shows how and where profits are decreasing.
Where does cash-flow come in?
For reporting purposes, a cash flow statement is the third financial document a company has to provide together with P&L and balance sheet. A cash flow statement shows where money came from and how it was used during a specific period, but doesn’t consider any outgoings or future income.
How important are accounting documents for contractors?
In practical terms, particularly for contractors, these documents are probably not going to be needed for any other purpose aside from being submitted to Companies House and HMRC annually – as this is a legal requirement of all limited companies.
You may also have to provide several years’ accounts to mortgage lenders if you are using company accounts to prove your income to get a home loan.
For other types of business, P&L accounts, balance sheet and the cash-flow statement are all important documents to let company owners know their businesses are performing.
They will also be used by potential investors and lenders to help assess how well the company is being managed and the efficiency of the business as a whole.