At the end of a given period of time, a business prepares financial statements to demonstrate its performance during that period, including an income statement and a balance sheet. An income statement reveals a company’s net profit or loss by subtracting different types of expenses from the company’s sales revenues. A balance sheet, on the other hand, reflects the impact a company’s bottom line has on the equity held by the owners of the business.
A balance sheet shows that the sum of a company’s assets equals the total of the company’s liabilities plus the equity that belongs to the owners of the business. To demonstrate the equation that governs a balance sheet, a balance sheet typically displays a company’s current and noncurrent assets on the right side of the statement, while listing the short- and long-term debts owed by the business on the left side of the statement. A balance sheet presents the equity belonging to the company’s owners on the left side of the statement, underneath the company’s liabilities.
Owners’ equity equals the residual or difference between the value of the assets owned by a business and the aggregate amount of the company’s debt. A balance sheet generally identifies different classifications of owners’ equity, including paid-in capital, retained earnings and treasury stock. The net profit or loss recorded on a company’s income statement affects retained earnings, meaning retained earnings increases when a business reports a profit and decreases when the business posts a net loss at the end of a period.
An income statement determines a company’s bottom line by subtracting its cost of goods sold, operating expenses and investment fees and taxes from the company’s revenue at different intervals of the statement. If a company’s revenue exceeds the sum of the expenses incurred by the business, the income statement records a net profit. If the total of a company’s expenses is more than the revenue the business generated during a given period, an income statement reports a net loss.
Revenue and Expenses
As long as the expenses incurred by a business do not increase, the business will increase the owners’ equity reported on the company’s balance sheet as it earns more revenue. If a business earns the same amount of revenue in consecutive periods while reducing the amount of its expenses, the business will increase its bottom line. The company’s balance sheet will reflect the increase in the company’s profitability by increasing the amount of owners’ equity recorded as retained earnings.