The balance sheet and the profit and loss account are two important sources of information about a company’s finances. They form part of what is known as the “financial statement” of the company. Few people outside of the accountancy profession know what these two statements are or how to read them.
Both the balance sheet and the profit and loss account present financial information about a company. Each has a set format and expresses details about the company in a different way. A simple method to work out the difference between these two is to think of the balance sheet as a snapshot of the company’s finances on a specific date and the profit and loss as a history book.
The first piece of information in the balance sheet, after the company name, is its date. This is often written as “as at ..” Remember, the balance sheet is a view of the company’s finances and so everything of value and every debt has to be accounted for in whatever form it lies on the date of the balance sheet. If the company is a manufacturer, then every piece of unfinished work currently crossing the shop floor has to be counted and given a value. That value will appear on the balance sheet as an asset, as will uncollected debts.
Profit and loss
The P&L is a history book, but it does not contain every transaction that occurred in the history of the company. It usually is produced to show the position of a company at its financial year end and covers the previous year’s trading. Even within that limited time frame, the history of the company’s life is not shown in detail, but is summarised into a few categories. Companies are obliged to publish a profit and loss account at the end of each year and everyone has the right to see it, so accountants give as little detail as is legally required to avoid disclosing trading secrets.
Although the P&L represents a history book, the balance sheet actually displays the accumulated consequences in financial terms of all the company’s life. It expresses the total value of the company on a specific date and that value would have been built up over the life of the company. The P&L, however, summarises the activities of the company over the past year. It expresses the company’s net reward rather than its net worth.
“Stakeholders,” such as investors, employees, suppliers, customers and regulators need to examine the P&L and the balance sheet to decide whether the business is a viable concern. The P&L shows whether the company made a profit in that year. The balance sheet shows how much a company is worth and where that money is tied up. The data given in these two documents provide a starting point for analysts who crunch these numbers to decide whether the company is a good investment and whether it is likely to pay its bills.