Question

For this week’s reflection, please write three complete and well-composed paragraphs and state which financial statement: (1) Balance Sheet or (2) Income Statement is more important to an outside investor. Explain your choice and why you think so.

Answer 1

To begin with, let us take a look at what Balance Sheet and Income statement means to an organization

BALANCE SHEET :-

Balance sheet is also knows as the Statement of Financial position. A Balance sheet consists of a detailed list of all the assets and liabilities of the company. Assets are the balances that the company owns or is expected to receive while liabilities are the balances which the company is obligated to pay in the future. Another important section of the Balance sheet is the Shareholders equity. The shareholders equity section displays important financial data regarding the number of shares issued by the company and outstanding, the share price, the capital, retained earnings etc. The balance sheet of any company should satisfy the following equation :-

Assets = Liabilites + Equity.

A look at the Balance sheet will help a user or a reader to obtain a bird's eye view of the company's current financial position. All the assets of the company like machinery, accounts receivable, property, plant and equipment, Stock, etc are few of the components of the assets side of the Balance sheet. While the liabilities section primarily include a company's long term obligations like Bonds payable, Mortgages, Loans payable and short term obligations like accounts payable, Interest payable, etc.

INCOME STATEMENT:-

A income statement is also called as a "Statement of Operations". Within this statement, all the expenses and income that a business encounters in its day to day functioning of the business are recorded here. The Income statement is a requirement by law and is a vital part of the company's core financial statements. All the information regarding the company's revenues, cost of goods sold, purchases, sales, general and administrative expenses, etc are recorded within the Income statement. The ability of the company's to generate Net profits based on the resources it possesses are a part of the income statement . Any prospective investor who wants to invest in the company can take a look at the Income statement of the company to analyse and introspect the company's earning and its ability to efficiently utilise the resources.

While both Balance sheet and income statement form the essence of the company's financial statements, Balance sheet would be more important for an outside investor because of the following reasons :-

i.) Balance sheet gives a true and fair view:-

A Balance sheet of a company gives a true and fair view of the financial position of the company. All the company's assets, obligations, equity , etc are mentioned within the balance sheet in order to benefit the stakeholders of the company that might include but not restricted to the investors, shareholders, regulatory authorities, etc. Balance sheet almost serves like a snapshot of the company's performance over the period.

ii.) Provides summary of the business operations:-

The efficiency, effectiveness and the competency of the company to generate profits, manage assets and reduce liabilites are all available within the balance sheet. Taking a look at this , it will help a prospective investor to analyze the company's current performance, compare between the periods presented, introspect the data, etc. The Balance sheet provides a complete summary of the business operations. Additionally, Working Capital Management is made easier by the processing of data and information available within the Balance sheet.

iii.) Helpful in analysis by using ratios:-

A Balance sheet of the company will be helpful in enabling a prospective investor or any stakeholder associated with the company to easily calculate and interpret the ratios. The liquidity ratios help to analyse the ability of the company to meet its short term obligations as they come due. The Debt to equity ratio helps us to understand the proportion of debt to the equity within the company and the return on assets ratio helps us to understand how effectively the company is able to generate returns on the assets it has employed.

iv.) Determination of Risk and return:-

A wide number of credit agencies issue loans or credit to the company . A look at the company's balance sheet will give them an overview of the current and the future obligations that the company already has and the look at the assets of the company will give an idea about the true value of the assets. By taking a look at the Balance sheet the credit agencies might find it easier and useful to conclude whether there would be a risk of lending to the company.