5.3 The Relationship between the Balance Sheet and the Income Statement
3 min read•june 18, 2024
Financial statements are like puzzle pieces that fit together to show a company's financial picture. The and work hand in hand, with flowing into and impacting . This connection helps paint a complete financial portrait.
Understanding how these statements interact is crucial for grasping a company's financial health. The shows earnings, while the reflects the resulting changes in , , and equity. Together, they tell the story of a company's financial journey.
The Relationship between the Balance Sheet and the Income Statement
Net income and retained earnings
Top images from around the web for Net income and retained earnings
Accounting: More than Numbers | OpenStax Intro to Business View original
Is this image relevant?
Account Categories | Accounting for Managers View original
Is this image relevant?
Valuing Different Costs | Boundless Finance View original
Is this image relevant?
Accounting: More than Numbers | OpenStax Intro to Business View original
Is this image relevant?
Account Categories | Accounting for Managers View original
Is this image relevant?
1 of 3
Top images from around the web for Net income and retained earnings
Accounting: More than Numbers | OpenStax Intro to Business View original
Is this image relevant?
Account Categories | Accounting for Managers View original
Is this image relevant?
Valuing Different Costs | Boundless Finance View original
Is this image relevant?
Accounting: More than Numbers | OpenStax Intro to Business View original
Is this image relevant?
Account Categories | Accounting for Managers View original
Is this image relevant?
1 of 3
- Net income represents the company's total earnings for a specific period after subtracting all from (salaries, rent, )
- Flows into the balance sheet through the account, a component of shareholders' equity
- Positive net income increases retained earnings, while negative net income decreases retained earnings
- Changes in retained earnings affect the balance sheet by altering total shareholders' equity and total or liabilities
- Increase in retained earnings results in an increase in shareholders' equity and total assets (cash, inventory)
- Decrease in retained earnings results in a decrease in shareholders' equity and total assets
Flow of financial statement information
- Income statement, , and balance sheet are interconnected financial statements
- Income statement reports the company's revenues, , and net income for a specific period
- Net income is the starting point for the statement of retained earnings
- Statement of retained earnings reconciles beginning and ending balances of retained earnings for a specific period
- Starts with beginning retained earnings balance
- Adds net income (or subtracts net loss) from income statement
- Subtracts paid to shareholders
- Ends with ending retained earnings balance
- Ending retained earnings balance from statement of retained earnings flows into shareholders' equity section of balance sheet
- Balance sheet presents a snapshot of company's assets, liabilities, and shareholders' equity at a specific point in time (December 31, 2022)
- complements these financial statements by showing the inflows and outflows of cash during a specific period
Expenses vs payables
- Expenses on income statement represent costs incurred by company during a specific period to generate revenue
- Cost of goods sold, salaries, rent, utilities,
- Subtracted from revenues to calculate net income
- Payables on balance sheet represent company's short-term obligations or liabilities from purchasing goods or services on credit
- , ,
- Recorded as liabilities on balance sheet until paid off
- Relationship between expenses and payables:
- When expense is incurred, recorded on income statement
- If expense not paid immediately, creates a payable on balance sheet
- When payable is settled, reduces liability on balance sheet, but does not affect income statement again
- This relationship is based on principles
Accounting Principles and Analysis
- Financial statements are prepared according to
- ensures that each transaction affects at least two accounts, maintaining the balance between assets, liabilities, and equity
- are used to analyze the relationship between different items on the balance sheet and income statement, providing insights into a company's financial health and performance
Key Terms to Review (29)
Accounts Payable: Accounts payable refers to the short-term debt obligations a company owes to its suppliers or vendors for goods and services received. It represents the amount a company owes to its creditors and is a crucial component of a company's working capital and cash flow management.
Accrual Accounting: Accrual accounting is a method of accounting that records revenues and expenses when they are earned or incurred, regardless of when the actual cash payment is received or made. This contrasts with cash-basis accounting, which records transactions only when cash is exchanged.
Apple, Inc.: Apple, Inc. is a multinational technology company known for its innovative products such as the iPhone, MacBook, and Apple Watch. It is also one of the largest publicly traded companies by market capitalization.
Assets: Assets are resources owned by a company that have economic value and can provide future benefits. They are listed on the balance sheet and classified as either current or non-current.
Assets: Assets are resources owned or controlled by an individual or organization that have economic value and can be converted into cash. They represent the items of value that a company or individual possesses, which can be used to generate future economic benefits.
Balance sheet: A balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It lists assets, liabilities, and shareholders' equity to give insights into the company's financial stability.
Balance Sheet: The balance sheet is a financial statement that provides a snapshot of a company's assets, liabilities, and shareholders' equity at a specific point in time. It is a fundamental tool for understanding a company's financial position and is essential for analyzing its financial health and performance.
Cash Flow Statement: The cash flow statement is a financial statement that reports the inflows and outflows of cash and cash equivalents over a specific period of time. It provides a comprehensive view of a company's liquidity and ability to generate cash from its operations, investing, and financing activities. The cash flow statement is a crucial component in understanding a company's overall financial health and performance.
Cost of Goods Sold: Cost of Goods Sold (COGS) represents the direct costs associated with the production and acquisition of the goods or services a company sells. It is a critical component in determining a company's profitability, as it directly impacts the gross margin and overall financial performance.
Depreciation: Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. It represents the gradual decline in an asset's value due to wear and tear, age, and obsolescence. Depreciation is a critical concept in understanding how a company recognizes sales, expenses, and the relationship between the balance sheet and income statement.
Dividends: Dividends are portions of a company's earnings distributed to shareholders, usually in the form of cash or additional shares. They provide an incentive for investors and represent a share of corporate profits.
Dividends: Dividends refer to the distribution of a portion of a company's profits to its shareholders. They represent the cash or stock payments made by a corporation to its stockholders as a return on their investment in the company's equity.
Double-Entry Bookkeeping: Double-entry bookkeeping is an accounting system where every transaction is recorded in at least two accounts, with a debit entry in one account and a corresponding credit entry in another account. This method ensures that the total debits are equal to the total credits, providing a self-balancing system that helps maintain the accuracy and integrity of financial records.
Expenses: Expenses are the costs incurred by a business in the process of earning revenue. They are recorded on the income statement and reduce net income.
Expenses: Expenses refer to the costs incurred by a company or individual in the process of generating revenue or carrying out its operations. They represent the outflow of economic resources required to sustain business activities and are a crucial component in determining a company's profitability, the relationship between its balance sheet and income statement, as well as the importance of forecasting for its future performance.
Financial Ratios: Financial ratios are quantitative measures that analyze and evaluate a company's liquidity, solvency, efficiency, profitability, and overall financial performance. They are essential tools for assessing an organization's financial health and making informed decisions.
Generally Accepted Accounting Principles (GAAP): Generally Accepted Accounting Principles (GAAP) are the standard framework of guidelines, rules, and procedures for financial accounting used in any given jurisdiction. GAAP provides a common set of accounting principles, standards, and procedures that companies must follow when compiling and reporting their financial statements, ensuring consistency and comparability across organizations.
Income statement: An income statement is a financial document that summarizes a company's revenues, expenses, and profits over a specific period. It provides insight into the company’s operational efficiency and profitability.
Income Statement: The income statement, also known as the profit and loss statement, is a financial report that summarizes a company's revenues, expenses, and net profit or loss over a specific period of time. It is a crucial document that provides insights into a company's financial performance and profitability.
Income statement (net income): An income statement (net income) is a financial report that shows a company's revenues, expenses, and profits over a specific period. Net income is the bottom line of the income statement, indicating the company's profitability after all expenses have been deducted from total revenue.
Liabilities: Liabilities are the obligations or debts that a company or individual owes to others. They represent the claims that creditors have on a company's assets and are a crucial component of the balance sheet, reflecting the financial responsibilities and commitments that must be fulfilled.
Net Income: Net income, also known as net profit, is the final and most important financial metric that represents a company's overall profitability and performance. It is the amount of revenue remaining after deducting all expenses, costs, depreciation, taxes, and other charges from a company's total revenue over a specific period of time.
Retained earnings: Retained earnings are the cumulative amount of net income that a company retains, rather than distributes as dividends to shareholders. They are reported on the balance sheet under shareholders' equity and reflect the company's reinvestment in its own operations.
Retained Earnings: Retained earnings are the portion of a company's net income that is retained or saved for future use, rather than being distributed to shareholders as dividends. This accumulated earnings account on the balance sheet represents the company's reinvested profits and is a key indicator of its financial health and growth potential.
Revenues: Revenues refer to the total income or sales generated by a business from its core operations. They represent the inflow of economic resources into the company, primarily from the sale of goods or services to customers. Revenues are a crucial component in the analysis of a company's financial performance and profitability, as they directly contribute to the company's overall earnings and cash flow.
Salaries Payable: Salaries payable is a current liability account that represents the amount of unpaid salaries owed to employees for work performed. It is an important component in understanding the relationship between the balance sheet and the income statement, as it reflects the accrual of compensation expenses incurred during an accounting period.
Shareholders' Equity: Shareholders' equity, also known as stockholders' equity, represents the residual interest in the assets of a company after deducting its liabilities. It reflects the amount that would be available to shareholders if a company's assets were liquidated and its liabilities paid off. Shareholders' equity plays a crucial role in the balance sheet, the relationship between the balance sheet and income statement, as well as in various financial ratios.
Statement of Retained Earnings: The statement of retained earnings is a financial statement that reports the changes in a company's retained earnings account over a specified period of time. Retained earnings represent the portion of a company's net income that is retained or saved for future use, rather than being distributed to shareholders as dividends.
Taxes Payable: Taxes payable is a liability account on a company's balance sheet that represents the amount of income taxes, sales taxes, and other taxes owed by the business to tax authorities. It reflects the company's obligation to pay these taxes within a certain time period.