Accounting – The Relationship between the Balance Sheet and Income Statement
For you to interpret your company’s financial statements effectively, you must understand the relationship between the various financial statements (Also see Types of Accounting Errors). But these relationships aren’t easy to see. Each financial statement shows up in a different page in your business annual financial report, and the threads connecting various statements aren’t written on that report. Therefore, it is up to you as the business owner to analyze these relationships, perhaps using financial ratios. Let’s find out how balance sheet and income statements are connected.
When you record a sale or an expense using the double entry accounting, you will see the interconnections between the balance sheet and the income statement. Note that an increase in sales will result in an increase in assets or a decrease in liability. On the other hand, expenses tend to increase a liability or decrease an asset.
This implies that one side of every expense or sale entry is also recorded in the balance sheet and the other side is recorded in the income statement. Therefore, the balance sheet and income statements are inseparable but are reported in separately.
To understand the relationship between a balance sheet and an income statement, consider the following.
- If you make sales and incur expenses for making those sales, your business needs to maintain a working cash balance.
- Credit sales (recorded in the income statement) creates accounts receivables (found in the balance sheet)
- If you intend to make sales, (recorded in the income statement) your business must have inventory (stock which is recorded in the balance sheet)
- To acquire inventory, you may need to purchase goods on credit and this creates the accounts payable
- Depreciation is recorded in the balance sheet and is also recorded in the accumulated depreciation contra account which appears in the income statement.
- The operating expense (found in the income statement) is a wide category of administrative, selling, and general expenses. These expenses appear in various accounts in the balance sheet including the accounts payable, accrued expenses account, and more.
From the above connections between the balance sheet and income statement, it is clear that every expense or income recorded in the income statement appears in the balance sheet. This raises a new question: is balance sheet the same as income statement?
The income statement shows all your business’s expenses and incomes over a period of time. Its main aim is to calculate how much cash flow your business generated or losses within a given period. On the other hand, a balance sheet indicates your business finances at one specific point in time. It reports three items: owner’s equity, liabilities, and assets. If this is not something you want to DIY, you can consider engaging an accounting firm in Singapore to help you out.