Comparing the Balance Sheets Versus Income Statements

0:05 all right 0:06 welcome i find that people often ask me 0:10 what's your favorite financial statement 0:11 the income statement or the balance 0:13 sheet 0:14 they're trying to figure out well you 0:15 know which one of these really is better 0:17 so that i can just focus on knowing it 0:19 that's kind of like asking me which one 0:21 of my kids do i love more 0:22 well maybe it's more like asking me do i 0:25 prefer salt or sugar 0:27 it really depends on the situation if 0:30 we're going to talk about the income 0:31 statement versus the balance sheet 0:32 why don't we start with how are they the 0:34 same 0:36 the biggest way that they're the same is 0:37 that they both use accrual accounting 0:40 that's that concept where we're trying 0:41 to capture what really has occurred 0:43 economically 0:44 rather than just focusing on cash we're 0:46 really trying to get the reality of 0:49 what's occurred this period and where we 0:50 stand right now 0:52 the other major similarity between them 0:54 is they both answer one of the two big 0:56 questions in life 0:58 now that's the way they're similar but 1:01 that also gives us their jumping off 1:02 point for how they're different 1:05 the balance sheet gives us this snapshot 1:07 in time so we're going to use it when we 1:09 think of questions like 1:10 how much are we owed by customers or how 1:13 much inventory do we keep in stock 1:15 or how much do i owe my suppliers each 1:18 one of those is telling us something 1:20 about where are we at 1:21 at a specific point in time the income 1:24 statement answers that second big 1:25 question 1:26 what happened this period so if we ask a 1:29 question like how many sales did we make 1:31 or what did it cost us to make those 1:33 sales 1:34 or how much interest did i incur this 1:36 year in all of those situations 1:39 we're going to look at the income 1:40 statement to try to figure out what 1:42 happened this period 1:43 now sometimes you might forget which 1:46 statement does which for me 1:47 the nice thing about the statements is 1:49 they actually remind you 1:51 if you were to take a look at royal bank 1:52 of scotland's balance sheet you'd see 1:55 that right on the top of it it says 1:56 consolidated balance sheet 1:58 s of 31 december 2016. 2:01 or what about mtm group that's one of 2:03 the largest mobile providers in africa 2:06 and there's a group statement of 2:08 financial position at 2:09 31 december 2016. notice both of these 2:13 are pointing out they're at a specific 2:15 point in time 2:16 that's answering that balance sheet 2:18 question of where do we stand right now 2:20 now you also might have noticed that mtm 2:22 group actually doesn't call it a balance 2:24 sheet 2:24 they call it a statement of financial 2:26 position but because they're telling you 2:28 it's capturing at a certain point in 2:29 time 2:30 you know that it's answering that first 2:32 big question in life where do we stand 2:34 and usually we would call that a balance 2:36 sheet what about the income statement 2:38 does it remind us as well 2:40 if you look at hsbc the big british 2:43 banks 2:43 financial statements you'll see on the 2:45 top of their income statement they say 2:47 consolidated income statement for the 2:49 year ended 31 december 2:51 and if you look at total the big french 2:54 oil company 2:55 you're going to see that even though 2:57 it's european instead of a british firm 2:59 it's still going to say the same thing 3:01 consolidated income statement for the 3:03 year ended 31 3:04 december if we were looking at u.s firms 3:07 the only difference you would see is it 3:08 would say for the year ended 3:10 december 31st instead it's still going 3:12 to remind you 3:13 this is the purpose of this statement 3:16 now 3:17 sometimes you're not just going to 3:18 answer one of the big questions in life 3:21 you're actually going to want to combine 3:22 those two big questions 3:24 where are we in a point in time as well 3:26 as what's happened over time 3:28 for example what if somebody said to you 3:30 did this manager make 3:32 good use of the investments that the 3:33 owners have put into the firm 3:35 well you'd need to know two things then 3:38 you need to know what value was created 3:40 over the time period this is giving us 3:42 that what happened over a certain period 3:45 you'd also need to know what did the 3:47 manager have during that period 3:50 or another way to think of that is what 3:52 was it that the owners had actually 3:53 invested and let the manager have use of 3:55 that's going to be a snapshot so we can 3:58 combine information from these two 4:00 statements to make something we call a 4:01 ratio 4:02 in this case we do something we call 4:04 return on equity we're going to take net 4:06 income 4:07 that's off the income statement and it 4:08 tells us something about what's happened 4:10 over time 4:11 and we're going to divide that through 4:12 by equity which is off the balance sheet 4:15 that tells us 4:16 how much had the owner's given the 4:18 manager to use during this time period 4:20 now we've got an entire set of videos on 4:23 ratios and we'll get into those in a lot 4:25 more detail 4:27 but it's important for you to understand 4:28 from the beginning that really 4:30 what a ratio is doing is still answering 4:32 one of those two big questions 4:34 which means it's going to draw from the 4:36 financial statements depending on 4:37 whether it's answering 4:39 the first big question the second big 4:41 question or something that's a 4:42 combination of the two 4:44 i hope this video has helped you 4:46 understand that both the balance sheet 4:48 and the income statement are important 4:50 and the one that's most important really 4:52 depends on what it is you're trying to 4:53 achieve 4:54 in a given situation now before i 4:58 leave that behind i do want to talk 5:00 about something that i've noticed over 5:02 time 5:03 it seems like it's a lot harder for 5:05 students to really get comfortable 5:07 with the income statement i was a little 5:10 surprised about this when i first 5:11 started teaching 5:12 but then i realized that was true for me 5:14 too eventually i 5:15 went over to speak with some of my 5:17 colleagues who study neuroscience the 5:19 way your brain works 5:20 as well as some colleagues who are 5:22 psychologists they told me that our 5:24 brains 5:25 actually have a very hard time with this 5:27 concept 5:28 of time in fact scientists don't exactly 5:31 know how our brains capture time even 5:33 now 5:34 so it's not surprising that trying to 5:37 think of things unfolding over time or 5:39 more difficult for us 5:40 that's actually the way everybody's 5:42 brain works not just yours 5:45 since i learned that i've tried to think 5:46 about a way to make this a little easier 5:48 for people 5:49 since i know that people naturally tend 5:51 to think more in the balance sheet 5:53 method 5:54 i've started to think of this analogy of 5:56 a flip chart like you had when you were 5:57 a kid 5:58 you'd draw a bunch of pictures and so 5:59 you flipped it the pictures would become 6:01 clearer to you 6:03 well if you think of the picture i'm 6:04 showing you here each one of these 6:06 individual flips is telling us something 6:08 about a point in time 6:10 but by putting all of those together 6:12 we're getting some sense of how this 6:14 tree changed over time 6:15 if it's easier for you with the income 6:17 statement you can think of it being made 6:19 up of 6:19 a whole bunch of individual snapshots in 6:21 time that are added together to give us 6:24 this flow 6:25 this sense of time occurring i hope that 6:28 this helps you 6:30 feel more comfortable with using the 6:31 income statement as well