Balance sheets and P&L accounts can give you rich insight into a company’s value. A balance sheet is an overview of a company’s assets, liabilities and equity capital. It’s a reflection of the company’s value at the end of the financial year. The P&L account provides an overview of all the company’s revenues and expenses. You can use this information to calculate the operating profit.
The balance sheet, quite simply, balances debit (or assets) against credit (or liabilities). These two columns should always equal the same amount.
Assets are items like cash, goods, buildings or receivables, and also include financial assets such as subsidiaries, and less tangible assets such as goodwill. As there are many different types of assets, these are then broken down into fixed assets and current assets.
Fixed assets are ‘fixed’ for longer than a year and include:
Current assets are items that can be converted to cash within one year and include:
The balance sheet’s liability column shows the company’s liabilities and equity capital. This can include long-term liabilities, like a mortgage, or short-term liabilities, like payables. It’s broken down this way:
The assets are always equal to the liabilities. This is called the balance sheet total and shows the company’s size in comparison to others in the same industry.
The P&L account, also called the income statement, is a snapshot of a company’s financial state for the entire financial year. The results are usually divided into three:
The P&L items are usually listed in order and divided into operating income and operating expenses. Operating income is the net turnover, which means it excludes VAT. Operating expenses are the various expenses to keep the company operating, and can include trade goods, services, salaries and raw materials.
Net profit is the final gain or loss once you’ve deducted all expenses, interest expenses, interest income and tax. Which means it’s a very critical figure when examining a financial statement. Thankfully, there’s a simple formal for calculating this:
operating income - operating expenses = operating profit (operational gains/losses)
interest expenses - interest income = gross gains/losses (gains/losses before tax; gross profit)
– taxes payable
= net profit.
This article is part of our series on reading financial statements, which you’ll be seeing more of over the next few weeks. Watch this space for our Reading a Financial Statement for Dummies guide – coming soon.