A balance sheet is an accounting document that all businesses use to keep track of their assets, liabilities and equity for their shareholders or owners. This document gives you an overview of a company's overall finances and how well it is making use of its assets to drive the company's profits. Although you can determine whether or not a business is profitable by looking at a balance sheet, typically, it is the income statement that provides specific information about a company's profits.
A company's balance sheet only contains information about the assets, including both short-term and long-term assets, the amount of equity invested in the company and all of the liabilities for the company at a specific point in time. It does not specifically list the company's profits. Assets can include cash, accounts receivable, inventory, property, patents and investments. Liabilities include debts, mortgages, wages to be paid, rent, accounts payable and utilities. When you subtract the liabilities from the company's assets, you get the equity for the shareholders or owners. The higher this figure, the more financially profitable a company likely is.
An income statement, also known as a profit and loss statement, is a separate accounting document from the balance sheet. It clearly delineates a company's profits, unlike a balance sheet. This document lists a company's sales, revenue and expenses over a period of time such as a fiscal year or quarter. The main purpose of this document is to calculate the net income for the time period. A company's net income is calculated by subtracting the overall expenses from the overall income and sales. Note that this could be a negative figure because some businesses may operate at a loss. For investors, you want to look for a company with a positive net income.
Although the balance sheet itself does not contain information such as a company's net income, it is a good indicator of whether a company is financially solvent and capable of producing a profit. What the balance sheet indicates is basically what would be left if a company and all of its assets was sold and settled all of its debts at once. If this is a positive figure, then the company is most likely profitable. Otherwise, if what you are left with is a negative number, then the company is not making good use of its assets to generate revenue for its investors. It's a good indicator for owners and lenders to see whether a company is one that is poised to expand or one that is struggling to survive.
The balance sheet and income statement are just two of the financial statements available that show the complete financial picture of a company. In addition, cash flow statements and statements of shareholder's equity give you more of an idea about a company's profits, losses and spending. Investors and lending institutions look at all of these financial documents to get an idea about whether or not the company is making financially sound decisions and how it has performed over a period of time. Remember, the balance sheet is simply a snapshot of a company's financial profile, which will change shortly after the sheet is produced. Thus, looking at other financial documents will give you a better idea about the profitability of a company over time.
