By DK Aggarwal
Balance sheet and profit and loss (P&L) statement are two of the three financial statements companies issue regularly. These statements provide an ongoing record of a company’s financial health and are used by creditors, market analysts and investors to assess the financial soundness and the growth potential of the business.
Now the question comes to mind is: Which one to look at when and for what. The simple answer is: both.
P&L and the balance sheet are the financial statements that work together to give a measure the company’s financial health. The balance sheet provides investors and creditors with a snapshot as to how effectively a company’s management is using its resources. The process of balance sheet analysis is used for deriving actual figures about revenue, assets and liabilities of the company.
On the other hand, a profit and loss statement summarises the revenues, costs and expenses incurred during a specific period of time.
From an operations point of view, profit and loss (P&L) is more important, but from a strategy point of view, balance sheet holds more significance.
At time a review of the profit and loss alone may tell you that the company is performing well, but the balance sheet can shed light on whether or not the company has enough funds to keep running its business.
When the economy is weak, it is obvious that corporate earnings will fall and we may have negative PAT and negative EPS. That doesn’t mean a company is weak and has no growth potential. In this scenario, the company’s balance sheet can give you the real picture and help identify good companies that have growth potential.
Cash and short-term investments, low or zero long-term debt and undervalued assets are some of the factors that investors should study closely in balance sheet. Another important point here is that each parameter is different and their assessment would depend intrinsically on the kind of business the company is in.
The primary objective of any investor is to earn profit from investing in stocks. The best way to check how successful a company has been is to read both P&L statement and balance sheet. Both can give important cues on whether or not it is a good business to invest in.
From an investor’s point of view, a consolidated profit and loss statement is more important than a standalone profit and loss account, since the former also accounts for the share of profits coming in from the company’s subsidiaries as the balance sheet does.
Chairman and MD, SMC Investments and Advisors