Analyzing the Balance Sheet and Income Statement Components

Posted on Oct 24, 2025 in Accounting and Finance

Understanding Core Financial Statements

The Balance Sheet: Definition and Components

The Balance Sheet is the primary accounting document that reflects the financial position of a company at a specific time. It adheres to the fundamental accounting equation.

Defining Net Worth (Heritage)

Net Worth (or Heritage) is defined as the set of goods, rights, and obligations of the company at any given time. This definition contains three key elements:

  1. Assets (Goods/Properties): The set of properties owned by the company.
  2. Rights (Receivables/Credits): Credits granted by the company to third parties.
  3. Obligations (Liabilities/Debts): Debts owed by the company.

The Fundamental Accounting Equation

In any Balance Sheet, the fundamental equation of Net Worth must be satisfied:

Assets = Equity + Liabilities

Structure of the Balance Sheet (Assets, Equity, Liabilities)

The Balance Sheet consists of three main sections: Assets, Equity, and Liabilities (Pasivo). Assets are grouped according to their nature and economic mass, while Equity and Liabilities are grouped by enforceability.

Assets (Liquidity Order)

Assets collect the monetary value of all property and rights of the company. Their composition shows how the money is invested. Assets are typically sorted from lowest to highest liquidity (least liquid items listed first).

Non-Current Assets (Fixed Assets)

These are property elements intended to serve as a lasting way in the activity of the company (held for more than one year).

  • Intangible Assets: Intangible assets susceptible to economic valuation (e.g., patents, goodwill).
  • Property, Plant, and Equipment (PPE): Tangible goods used in the production and trade activities of the company.
  • Investment Property: Tangible items held not for production or trade, but for capital appreciation or rental income.
  • Long-term Financial Assets: Financial assets on which the company has a criterion of permanence (long-term holding).
Current Assets

These assets are subjected to a continuous cycle of renewal (expected to be realized, sold, or consumed within one year).

  • Inventory (Stock): Items held for sale or consumption in the productive and commercial activity.
  • Trade Receivables (Debtors): Debts owed by individuals, companies, or institutions.
  • Cash and Cash Equivalents (Available): Cash available in the company’s cash box and bank accounts.

Equity and Liabilities (Enforceability Order)

This section collects the monetary valuation of resources that have helped finance the assets and rights. Elements are sorted from least to greatest enforceability. The enforceability of a liability depends on the time limit within which it must be returned to its holders.

Equity

Resources that the company does not owe to any external creditor (e.g., capital, reserves, retained earnings).

Non-Current Liabilities

Resources for which there is a commitment to refund within a period exceeding one year (long-term debts).

Current Liabilities

Debts due set equal to or less than one year (short-term debts).

The Profit and Loss Account (Income Statement)

The Profit and Loss Account (P&L) details the company’s financial performance over a period. The major components are calculated sequentially to determine profitability.

Calculating Operating Profit

The calculation begins with core operational activities:

  1. Net Revenue (Turnover): Value of sales made during the year. (+)
  2. Cost of Supplies/Purchases: Value of purchases of goods, components, and raw materials. (-)
  3. Staff Costs: Salaries of employees and social security contributions. (-)
  4. Other Operating Expenses: Costs like electricity consumption, gas, water, and telephone. (-)
  5. Depreciation and Amortization: Impairment of assets due to wear or obsolescence. (-)
  6. Impairment and Gains/Losses on Disposal of Non-Current Assets: Fixed assets losing value (other than depreciation) and results from the sale of fixed assets (positive or negative). (+/-)

A) Operating Profit (EBIT): The addition and subtraction of the previous concepts.

(The Operating Profit allows stakeholders to know the progress of the company’s core activities before accounting for interest on debts and income tax.)

Determining Net Profit

After calculating operating results, financial and tax impacts are included:

  1. Financial Income: Income derived from financial transactions and bank deposits. (+)
  2. Financial Costs: Costs incurred from financial transactions and bank deposits. (-)

B) Financial Result: The sum of Financial Income and Financial Costs.

(The Financial Result determines the influence of the company’s financial activities, such as interest paid on loans taken, on overall results.)

C) Profit Before Tax (PBT): Operating Profit (A) + Financial Result (B).

(Profit Before Tax is the total profit before deducting income tax.)

D) Net Profit or Loss: Profit Before Tax (C) minus Income Tax Expense.

  • Income Tax Expense: Corporation tax calculated using the applicable rate on the taxable amount (Profit Before Tax). (-)

(Net Profit or Loss is the final result after deducting income tax.)