Difference Between Balance Sheet and Profit & Loss Account (With Simple Example)

Emma runs a small online store. Her profit and loss statement shows high sales and substantial profits, giving her confidence in this year’s performance. However, the balance sheet reveals that the company still owes money to suppliers. It’s then that she realises the two statements reflect different financial situations. This article will explore the differences between the balance sheet vs profit and loss statement, and how they are interrelated.

What is a Balance Sheet?

A balance sheet is a snapshot of a company’s financial situation at a given point in time – usually the end of a fiscal year. It’s a pretty straightforward document that spells out what you’ve got (assets), what you’re owing (liabilities), and what you’ve got left over to call your own (equity) in the business.

We’ve got this simple accounting formula that the balance sheet follows:
Assets = Liabilities + Equity

But that’s not all – the balance sheet is also a key tool for business owners, investors, and accountants to get a sense of how solid a company’s financial footing is, and what its net worth is. When you dig into the numbers in the balance sheet, you can get a clear picture of whether the company’s assets can cover its liabilities, and how well its managers are handling the company’s financial resources.

What is a Profit & Loss Account?

A Profit & Loss Account (or P&L for short) is another type of financial statement that tells you how a company is doing over a specific period of time, like a month, a quarter, or a year. It’s a way of keeping track of how much money the company’s taking in, and how much it’s spending – so you can work out whether it’s raking it in or losing money.

Armed with this information, businesses can start to make sense of how to cut costs, boost income, and make better financial decisions.

Difference Between Balance Sheet vs Profit and Loss Account (Side-by-Side Comparison)

Balance Sheet and the Profit and Loss Account (P&L) are important financial statements. But both have different functions and provide various sorts of financial data.

Basis of Comparison	Balance Sheet	Profit & Loss Account
Purpose	Shows the financial position of a business	Shows the financial performance of a business
Time Period	Snapshot at a specific point in time	Covers a specific period such as a month, quarter, or year
Main Components	Assets, Liabilities, and Equity	Revenue, Expenses, and Profit or Loss
Focus	What the business owns and owes.	How much income the business earned and spent
Objective	Measures financial stability and net worth.	Measures profitability of the business
Accounting Formula	Assets = Liabilities + Equity	Revenue – Expenses = Profit or Loss
Use for Decision Making	Helps assess financial strength and liquidity	Helps evaluate operational performance

In simple words, the Profit & Loss Account describes how much profit the company produced during a given time, and the Balance Sheet reveals the company’s entire financial condition at a specific date. Both statements work together to provide a thorough view of a company’s financial situation.

How the Balance Sheet and Profit & Loss Account Work Together?

The Balance Sheet and the Profit and Loss Account – they’re totally intertwined and give you a complete view of a company’s financial well-being. The P&L shows you exactly how much profit or loss a business made over a certain time period. Then the Balance Sheet takes it a step further by telling you where the business stands financially at the end of that time.

Profits made on the Profit & Loss Account get slotted into the Balance Sheet’s equity section, where they’re usually tagged as retained earnings. So when a business racks up a profit, its equity goes up, but if it’s losing money, equity takes a hit.

When you look at both statements together as a single unit, business owners and accountants can get a real clear picture of how the company’s doing financially- Did they hit their profit target, or did they end up in loss? If they did lose money, they could take action to prevent that from happening again in the future.

Practical Example of Balance Sheet vs Profit & Loss Account

Let’s go back to Emma’s online store.

Emma analyses her profit and loss statement and discovers that the company achieved significant sales during the year. After deducting expenses like advertising, packing, website costs, and shipping fees, the statement indicates a solid net profit. This helps the company appear financially successful.

However, when Emma examines the balance sheet, she sees a different image. As per balance sheet record, she has yet to pay suppliers for inventory purchased earlier this year. It also shows the cash balance in the bank and the value of the remaining stock.

This example highlights the difference between the two statements:

• The profit and loss account indicates how much profit her business made or incurred loss during a given period.
• The balance sheet displays the business total financial condition at a given date, including assets, liabilities, and equity.

In Emma’s example, the profit and loss account demonstrates that the business is profitable, but the balance sheet indicates that the company still has financial responsibilities to meet. Together, these two financial statements provide a comprehensive picture of the company’s financial condition.

When Should Business Owners Use Each Statement?

Profit & Loss Account is used when:

• Review business profitability for a month, quarter, or year
• Analyse sales performance and operating expenses
• Identify areas to reduce costs or improve margins
• Prepare budgets and financial forecasts

A balance sheet is used when:

• To check the overall financial position of the business
• Understand assets, liabilities, and business net worth
• Apply for loans or attract investors
• Evaluate the company’s financial stability and liquidity

Key Differences Between Financial Statements and Management Accounts

Basis of Comparison	Financial Statements	Management Accounts
Purpose	Prepared to show the overall financial performance and position of a business	Prepared to help managers make internal business decisions
Users	External stakeholders such as investors, lenders, and regulators	Internal users such as business owners, managers, and executives
Frequency	Usually prepared annually or quarterly	Prepared more frequently, often monthly or weekly
Regulation	Must follow accounting standards and legal requirements	Not legally regulated and can be customised based on business needs
Focus	Focuses on past financial performance	Focuses on both past performance and future planning

Emma prepares monthly management reports for her eCommerce business. The report shows that, while her sales are good, a significant portion of her cash is locked up in unpaid supplier invoices and unsold inventory.

Emma chooses to cut back on stock purchases for the next month and instead focus on selling existing products. She also organises supplier payments more carefully to ensure a steady cash flow.

This allows Emma to avoid financial shortages and better manage her business finances.

How to Prepare an Income Statement (Basic Overview)

Preparing an Income Statement (Profit & Loss Account) entails documenting all of a business’s income and spending over a specified time period in order to establish whether the business generated a profit or a loss.

Basic steps include:

• Record Total Revenue: Begin by detailing all of the revenue generated by sales or services during the time.

• Calculate Cost of Goods Sold (COGS): To calculate gross profit, subtract the direct costs associated with the production of goods or services.
  The Cost of Goods Sold (COGS) formula is:
  COGS = Opening Inventory + Purchases − Closing Inventory
  
  This formula calculates the direct cost of making or purchasing products sold during a given time period.
  
  • Example:
    Emma owns a small online company that sells handmade goods. At the beginning of the month, she had £5,000 in inventory.
    
    During the month, she acquired £3,000 in additional merchandise from her vendors. By the end of the month, following multiple transactions, her store’s remaining inventory was worth £2,000.
    
    COGS = £5,000 + £3,000 − £2,000
    COGS = £6,000
    This means Emma spent £6,000 on the things that were actually sold during that time. She can now use this figure in her profit and loss statement to compute her gross profit.

• List Operating Expenses: Include expenses such as rent, salaries, utilities, marketing, and office costs. (If you want to get an in-depth understanding of what expenses to claim, read our blog – Eligible Business Expenses to claim for different industries)

• Calculate Operating Profit: Subtract operational expenses from gross profit to calculate the profit from core business operations.

• Account for Taxes and Other Costs: Deduct taxes, interest, or other additional expenses.

• Determine Net Profit or Loss: The final figure indicates whether the company made a net profit or a loss during the period.

Conclusion

The primary motive of this blog was to give a basic understanding of how a balance sheet and a Profit &Loss account differ from each other.

Both financial statements are essential in assisting business owners, accountants, and stakeholders to make sound financial decisions. Businesses that review them together might have a better understanding of their profitability, financial stability, and long-term growth potential. Contact us today to get your statements streamlined.

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