Financial statements play a significant role in organizations. Income statements and balance sheets are arguably the most significant reports used in summarizing the financial performance of a company. The income statements measure a company’s profitability over a given period, while the balance sheet shows the value of an organization’s assets and liabilities on a specific date. The reason why the income statement is also called profit and loss and meaning of the word balance in the balance sheet are arguably the most difficult ideas in the effective use of the two financial statements.
The terms income statement and profit and loss statements are used interchangeably. Although the two reports are organized differently, they serve the same purpose. The income statement calculates the net profit value of an organization by deducting total expenses from the total revenue. On the other hand, the profit and loss account comprises of different classes of transactions that help companies monitor their revenues and costs. Both income and profit and loss statements are the same because they help companies to find out sources of revenue and expense and the differences between the two variables is the net profit.
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A balance sheet is usually divided into two halves, which have the same value. The word balance in the balance sheet refers to the total value of a company’s property, liabilities, and shareholders’ investment after the completion of organizational activities over a period. For example, the remaining assets value is calculated by adding the net assets to new purchases and reducing the disposals to determine what is left or the balance. Similar calculations are made for the equity and liability values.
The double entry principle explains why the balance sheet is divided into two halves. According to the double entry principle, every activity undertaken in an organization must affect accounts that are usually a credit and debit. Notably, all the asset accounts are debited, while the equity and liability accounts are credited. Therefore, when the balance sheet is created, the credit and debit sides, which are the two halves of the statement, must balance.
