Relationship Between Balance Sheet and Income Statement

What is the Relationship Between Balance Sheet and Income Statement?

The relationship between balance sheet and income statement is that the profit of the business shown in the income statement, belongs to the owners and this is shown by a movement in equity between the opening and closing balance sheets of the business.

The Opening Balance Sheet

Suppose the business starts off with the owner injecting cash of £600 into the business bank account. The opening balance sheet is shown below, the business has an asset of cash of £600, and the owners equity in the business is £600.

Relationship Between Balance Sheet and Income Statement
Opening Balance Sheet
Balance sheet Opening
Cash 600
Accounts receivable
Net assets 600
Equity 600
The Closing Balance Sheet

The business now trades for an accounting period. It buys goods costing £500 for cash and sells them on credit to customers for £800.

In balance sheet terms, the asset of cash has fallen by the amount we paid to the supplier £500, and the closing cash balance is £600 – 500 = £100.

The accounts receivable have increased by £800 which is the amount due from the customers, and the closing accounts receivable is £0 + 800 = £800.

Using this information the business can now produce a closing balance sheet, shown below.

Relationship Between Balance Sheet and Income Statement: Opening and Closing Balance Sheets
Balance sheet Opening Closing
Cash 600 100
Accounts receivable 800
Net assets 600 900
Equity 600 900

Because the net assets are now £900, to maintain the accounting equation, and make the balance sheet balance, the equity must also be £900.

The Balance Sheet Movement

If we now add another column to show the movement on the balance sheets we get the following.

Relationship Between Balance Sheet and Income Statement: Balance Sheet Movement
Balance sheet Opening Closing Movement
Cash 600 100 -500
Accounts receivable 800  800
Net assets 600 900  300
Equity 600 900  300

Two of the movements can be explained. The movement on cash is -£500, the amount paid to the supplier. The movement on accounts receivable is £800, the amount invoiced and outstanding from customers. However, to make the balance sheet balance there has to be a movement on equity of £300, which needs to be explained.

The Income Statement

The explanation for the movement in equity lies in the relationship between balance sheet and income statement. If we now look at the income statement for the period we see the following.

Relationship Between Balance Sheet and Income Statement: Income Statement
Revenue 800
Costs 500
Profit 300

The income statement reflects the fact that the business sold goods costing £500 for £800 and made a profit of £300. The profit belongs to the owners and increases the owners equity by £300. This increase is the same as the movement in equity between the opening and closing balance sheets.

So the relationship between balance sheet and income statement is that the profit for the period which comes from the income statement, represents the movement on equity which is the difference between the opening and closing equity in the balance sheets of the business.

Profit for the period (income statement) = Movement in equity (balance sheet)

Return to the Small Business Accounting Course

Relationship Between Balance Sheet and Income Statement November 6th, 2016Team

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