Which is more important – P&L A/C or your Balance Sheet?

Profit & Loss A/C or Balance Sheet? Though both are separate financial reports, they are inter-linked and only collectively reflect a business’s health. Hence, it is important to understand their similarities and their difference.

A Balance Sheet bearing both assets and liabilities is a reflection of past performance as well as a measure of a business’s future capability. On the other hand, a profit and loss statement (P&L), showing earnings, expenses and net profit, throws light on the current state of affairs and indicates where a business is going in the future.
Read together, these two financial statements offer invaluable insights into a business’s performance and potential.

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Profit & loss A/C or Income Statement
• It provides information on how a business performed over its accounting period (normally, a financial year).
• It provides detailed view of all income and expenditure of that accounting period, such that comparisons can be made with past performance or budgeted expectations

Balance Sheet
• It shows the extent of your business’s ownership of assets, liability and equity at a given point in time.
• It shows how much cash your business has on hand and also identifies the most valuable assets of the company.
• It helps you to keep a constant eye on the quantum of your debts, and helps you to decide when and how to service them
• Your Balance Sheet will be referred to by all your stakeholders (banks, financiers) in order to gauge your business’s strength and potential
There are several notional elements in a Profit & Loss a/c and the big factor which is not taken into account is movements in working capital. Anyone who has run a business knows that it is one thing to sell an item or a service at a price that produces a profit, but unless customers pay up on time that profit is not secure and is, at worst, an illusion. This simple fact needs to be borne in mind when you look at your P&L a/c. It is, therefore, imperative that you read your Balance Sheet along with the P&L a/c. If you do this, you will know how soon your customers will pay you and therefore give you the power to assess your cash inflows and outflows.

Finally, from an operations point of view, P&L is more important, but from a strategy point of view, Balance Sheet is more valuable. A review of the P&L alone may give the appearance that the company is performing well, while a standalone review of the Balance Sheet can highlight the fact that the company may be in financial trouble.

If you look at one, without reviewing the other, you may get an incorrect financial snapshot. Only by reviewing both the P&L and the Balance Sheet can you truly assess the financial performance and potential of your business.