Every business, whether big or small, must maintain accurate financial records to assess its performance and financial position. Balance Sheet and Profit & Loss Account (also called Income Statement) are the two financial statements that reflect the true health of a business.
Despite these two terms being part of the same financial statements, they each serve different purposes. The Profit & Loss Account shows the profit of a company for a specific period, and the Balance Sheet shows a company’s financial position on that specific date.
For business owners, accountants or even university students in commerce and law studies, it is essential to understand the difference between the two. Let’s take a closer look at what they represent, where they differ, but most importantly, why both are required to assess a business’s financial performance.
What is a Profit & Loss Account?
A Profit & Loss Account (P&L Account) is a statement that summarises all revenues, expenses, and gains or losses of a business during a specific accounting period, usually one year.
Its main purpose is to determine whether the business has made a profit or incurred a loss during that period. It reflects the performance of the business rather than its financial position.
Structure of a Profit & Loss Account
1. Income/Revenue:
This includes all earnings from the core operations of the business, such as sales of goods or services, commission, or other business income.
2. Expenses:
These are costs incurred in earning the revenue, such as salaries, rent, electricity, raw materials, depreciation, and interest expenses.
3. Profit or Loss:
- If total income exceeds total expenses → the result is a net profit.
- If total expenses exceed total income → the result is a net loss.
Example
If a business receives total revenue of ₹10,00,000 in the financial year and overall spends ₹8,00,000 in financial expenses, the final Profit & Loss Account will show a profit of ₹2,00,000.
What is a Balance Sheet?
A balance sheet is a statement of finances which gives a snapshot of the financial position of a business at a given point in time, usually at the end of the financial year. The reason it is called a balance sheet is that it stems from a basic accounting equation:
Assets = Liabilities + Owner’s Equity.
In simple terms, the assets or what a company owns will always be equal to the liabilities or what it owes and equity or owner capital.
Structure of a Balance Sheet
1. Assets
- Current Assets: Cash, bank balances, stock, receivables, etc.
- Non-Current Assets: Land, buildings, machinery, furniture, vehicles, and intangible assets like goodwill or patents.
2. Liabilities
- Current Liabilities: Creditors, short-term loans, outstanding expenses, etc.
- Non-Current Liabilities: Long-term borrowings, bonds, or debentures.
3. Owner’s Equity (Capital)
- This represents the owner’s investment plus retained profits (or less losses).
- The Balance Sheet helps stakeholders assess what the business owns and owes at a particular point in time.
Key Differences Between Balance Sheet and Profit & Loss Account
| Basis of Difference | Balance Sheet | Profit & Loss Account |
| Meaning | Shows the financial position of the business on a specific date. | Shows financial performance over a specific period. |
| Purpose | To know what the business owns (assets) and owes (liabilities). | To know whether the business earned a profit or suffered a loss. |
| Time Frame | Prepared as on a particular date (e.g., 31st March 2025). | Prepared for a specific period (e.g., 1st April 2024 – 31st March 2025). |
| Contents | Assets, Liabilities, and Capital. | Income, Expenses, Profit, and Loss. |
| Nature of Account | It is a statement of position (real and personal accounts). | It is a nominal account (records incomes and expenses). |
| Objective | To determine the financial strength and solvency of the business. | To measure operational performance and profitability. |
| Dependency | Prepared after the Profit & Loss Account, since net profit/loss affects capital. | Prepared before the Balance Sheet to determine net profit or loss. |
| Frequency | Usually prepared at the end of the financial year. | Can be prepared monthly, quarterly, or annually. |
| Example of Items | Cash, Debtors, Creditors, Loans, Fixed Assets. | Sales, Rent, Salaries, Interest, Purchases, Depreciation. |
Connection Between Balance Sheet and Profit & Loss Account
Even if separate, there is a strong link. The net profit or loss from the Profit & Loss Account will be transferred to the Balance Sheet.
- If the business has profit, then it will be part of the owner’s capital in the Balance sheet.
- If it incurs a loss, it is deducted from the capital.
This connection ensures that the Balance Sheet always reflects the updated financial position after accounting for the results of operations.
Why Both Statements Are Important?
- For Business Owners: They provide a complete picture of how much the business has earned and how strong it is financially.
- For Investors: Investors use these statements to assess whether a company is profitable and financially stable before making investment decisions.
- For Lenders and Banks: Banks and financial institutions rely on both documents to determine a borrower’s repayment capacity and credibility.
- For Government and Tax Authorities: These statements help ensure accurate tax computation and compliance with accounting laws.
- For Legal and Regulatory Purposes: Under the Companies Act, 2013, every registered company in India must prepare a Balance Sheet and Profit & Loss Account at the end of each financial year, as part of its financial statements to be filed with the Registrar of Companies.
Mistakes to Watch Out For
- Confusing both reports – Many small business owners do not realise that they both serve two different purposes, while one shows performance and the other shows position.
- Forgetting to do this regularly – Both reports should be done on a regular basis and not just at year’s end.
- Failing to match totals – Make sure the closing balance on the P&L Account agrees with the Capital section of the Balance Sheet.
Conclusion
In conclusion, the Profit & Loss Account is comparable to a film as it shows how the business performed over a time period, while the Balance Sheet is comparable to a snapshot as it demonstrates the financial position as of a moment in time.
Both statements are critical to understanding the health of the business, as the Profit & Loss Account demonstrates the performance of the business, while the Balance Sheet demonstrates the financial stability.
These two statements are part of the base of financial reporting and decision-making.
For the entrepreneur, accountant, lawyer, etc, understanding the two statements is paramount to transparency, compliance and sound business growth.
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