Income Statement vs Balance Sheet
When it comes to personal and corporate finances, it is vital to understand the difference between income statements and balance sheets.
When it comes to personal financial education, it’s important to know the difference between balance sheets versus income statements. Although used in both the corporate world as well as personal finances, we will focus on the latter in this article. Although complementary, an income statement versus balance sheet actually measure different things and therefore, after review and analysis, will give you different yet equally important conclusions.
Financial freedom starts by being honest about 3 things:
- how much you earn
- how much you spend (including fixed expenses) and
- how your investments are doing
Although writing down the above may be difficult and challenging for some people, knowing where money is coming out and leaving your pocket is ultimately the key in understanding where you are financially. And knowing more about your finances will not only increase your financial IQ, but it will also support you in making the right financial decisions for you and your family.
After thinking about the above, you can read more about personal income statements versus balance sheets below.
What is a Personal Income Statement?
A personal income statement includes how much money comes in and how much money goes out of your pocket over a specific duration of time. You can determine your “cash flow” from a personal income statement.
Income includes all sources of earnings. Some people may only have one source of income, whilst others may have multiple.
There are 3 types of personal income: earned, portfolio and passive. Earned income includes your wages, tips, salaries, commissions etc. Portfolio income includes sales of assets (such as stock equities, real estate etc) and is also called capital gains. Passive income includes all sources of positive consistent cash flow without you having to work (such as rental income from rental properties).
The combination of all 3 types of income and all sources of income within each type will give you your ‘Total Income‘ for your Income Statement.
This is where it may get challenging for some people. Knowing and understanding where all your money goes out of your pocket is the key to determining an accurate financial picture for yourself. How much do you spend every month? What do you spend your money on? What expenses are fixed and what are variable? What’s a need versus a want? These are some of the questions you must ask yourself. All expenses must be recorded in your income statement.
The Outcome of a Personal Income Statement
If your Income is higher than your Expenses every month, then you are NOT ‘living beyond your means’. However, this does not mean that you are being financially responsible nor does it mean that you will be financially free. It does tell you that your total income is enough to cover all of your expenses and debt, which is a good thing.
If your Expenses are higher than your Income each month, then you are ‘living beyond your means’. What this means is that you are not generating enough income to cover all of your expenses and debt. This is where the ‘rat race‘ continues and how oftentimes, increasing debt spirals uncontrollably.
If you find yourself in this situation, its best to understand where your money is flowing out (expenses) and determining what is fixed versus variable and a want versus a need. Or, alternatively, you can find more sources of income to satisfy your current lifestyle.
Personal Income Statements and Cash Flow
Therefore, when you look at the relationship between Income and Expenses, you can calculate your Cash Flow. Cash Flow = Income minus Expenses. If your income exceeds expenses, then you have positive cashflow. If your expenses exceed income, then you have negative cash flow. You want to be cashflow positive.
What is a Personal Balance Sheet?
A personal balance sheet is a list of everything you own (assets) and everything you owe (liabilities) at a specific moment in time. You can determine your “net worth” from a personal balance sheet.
Essentially, a balance sheet consists of all your assets (anything that has value) and your liabilities (anything that you owe). We’ll take a look further:
A personal balance sheet includes both investment assets and personal assets. In regards to investments, there are 5 major asset classes that include: Paper Assets (like stocks), Commodities, Business, Cryptocurrencies and Real Estate. Personal assets include such things as collectibles, jewelry, artwork etc. All assets should be entered into a personal balance sheet.
Just like expenses in an income statement, working out your liabilities for your balance sheet might be challenging for some people. Liabilities are anything you owe which can include any type of debt, mortgage, HELOCs, unsecured and secured line of credit (LOC), personal loans, car loans and student loans.
The Outcome of a Personal Balance Sheet
If your Assets exceed your Liabilities, you are in good shape. This means that the things that you own have more value than what you owe. A personal balance sheet will allow you to analyze what’s working and do more of it, as well as what is not working so you can cut it out.
If your Liabilities exceed your Assets, then you have some work to do to try and balance it out. Analyze where you can increase your assets or lower your liabilities. If you can, consolidate your debt.
Personal Balance Sheets and Net Worth
Therefore, when you look at the relationship between Assets and Liabilities, you can calculate your Net Worth. Net Worth = Assets minus Liabilities. If your assets exceed liabilities, then you have a positive Net Worth. If your liabilities exceed assets, then you have a negative Net Worth. You want to have a positive net worth.
Personal Income Statement versus Balance Sheet in a Nutshell
|Income Statement||Balance Sheet|
|Specific duration in time||Snapshot in time|
|Cash Flow||Net Worth|
|Shows performance||Does not show performance|
|Used by lenders to determine|
if you can pay liabilities
|Used by lenders to determine|
amount of credit to extend