Question

The income statement measuring the organization’s performance such as determining profits and losses. The balance sheet does this as well, except that it measures the net worth, which is based on assets. The income statement measures the performance by showing the profitability of a company based on its revenue (income).The other advantage of the income statement is that it shows the flow of revenues and expenses over a period of time.

With that said, if the organization was applying for a loan, what would be the purpose of the financing institution looking at both the income statement and balance sheet if they basically show the same information?

Answer 1

The Income statement and Balance sheet are part of financial statements of a company. The income statement presents information about performance of the entity, while Balance sheet presents financial position.

Performance of the company relates to the revenues earned and expenses incurred, while financial position provides information about the assets controlled and liabilities of the company. The two statements are related. The net profit in Income statement is added to Retained earnings under equity section of the Balance sheet.

The reasons loan or capital providers investigate both the statements are as follows:

- The two statements are related, but not the same. The two statements present different aspects about financial status of the entity. The income statement provides information about how the revenues are earned, and what kind of expenses are incurred. The Balance sheet presents the details of assets and liabilities. The loan providers need to understand if the company has sufficient profits to continue the business or if there is any need to sell the assets for day-to-day business. In the Balance sheet, they need to understand if the company has enough current assets for day-to-day functioning or a need to sell fixed assets might arise.

- The Income statement is analyzed to understand the composition of total revenue and total expenses. They need to understand if the revenue is earned through operating activities of the business or other activities. Ideally, revenue must be earned through operating activities to ensure sustenance in the future. The Balance sheet is analyzed to understand if the company has enough fixed and current assets in comparison with current liabilities and long-term liabilities.

The two statements are interrelated but do not give the same information. Hence, the loan or capital providers look at both of them to analyze various aspects of the company.