Why We Need an Income Statement and a Balance Sheet

reportsOr alternatively, why we need a Statement of Activities and a Statement of Financial Position, to use nonprofit-financial speak.  I was asked this question at a recent training, as I have been asked many times over the years.  I have been asked why we can’t have just one statement to show everything, one statement to make things easier.  The two reports are not a deliberate effort to confuse us but an attempt to tell the financial story of an organization.

But just one combined report is nigh on impossible because each report tell us a different story.  From About.com we have this classic definition:

The business firm’s balance sheet shows how much money the firm is worth or its net worth. The balance sheet is stated in terms of book value.

The income statement (statement of profit and loss) shows how profitable the firm is. A positive net income means the firm is making money. A negative net income means the firm is losing money.

The balance sheet is an indicator of net worth while the income statement or statement of profit and loss is an indicator of profitability.

Another explanation, combined from several sources:

The main item linking the Statement of Financial Position and Statement of Activities is Net Assets. In the for-profit world “net assets” would be known as equity, or the owner’s stake in the business.  The Statement of Activities provides a detailed explanation of the most important change in equity, i.e. the net income/ (loss) for the accounting period. At the end of the period this is transferred to the Statement of Financial Position in the form of equity.

Revenue (cash, or promises to give us cash, received from operations) increases our net assets. Expenses (cash spent during operations) decrease our net assets. The net difference between revenues and expenses is the net income (or loss).

One, the income statement, tells about what we have done in a given time period (month, quarter, fiscal or calendar year): the income earned, bills paid, etc.  The changes here (profit or loss for the given period) are totaled up and moved to the balance sheet.

The other, the balance sheet, is a snap-shot in time of where we are asset-wise at the moment the report was made.  It shows how much money we have in the bank, how much money is owed to us in the form of grants receivable or other accounts receivable and how much money we owe (liabilities).  It also shows us in dollars and cents how much our other assets, like automobiles, buildings, or computers are worth.

In short, the balance sheet or statement of financial position shows the measure of our financial worth and the income statement or statement of activities reflects all the changes to that worth.  One is incomplete without the other, together they help tell the whole story.

Does that help?

6 responses to “Why We Need an Income Statement and a Balance Sheet

  1. Yes! Yes, that helps very much! Thanks.

  2. This is great! Thanks!

  3. sally anggono

    thank you!
    it helps me on my assignment


  4. yes! it does! what about The Statement of Cash Flows? is it used in not for profit accounting?

  5. It is, but for most nonprofits it is not that useful. The statement of cash flows show how money moves through an organization by operations, debt financing and investing. Since most nonprofits don’t do a lot of debt financing or investing, it isn’t as useful a report in my opinion.

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