Balance sheet and income statement relationship

How do the income statement and balance sheet connect and interact? Which financial statement is more important: the balance sheet or the income statement? The answer is: both! They each have their own focus and purpose. This video provides you a deep understanding in less than five minutes.
⏱️TIMESTAMPS⏱️
00:00 Intro
00:21 What is a balance sheet
00:51 What is an income statement
01:13 Balance sheet and income statement relationship
01:35 Raising capital
02:00 Plant and Equipment (P&E)
02:17 Buying inventory from supplier
02:33 Recording expenses
02:59 Sales transaction
03:19 Profitability
03:40 Retained earnings
The balance sheet is an overview of a company’s assets and liabilities at a point in time, usually the end of a quarter or the end of the year. A balance sheet shows you what a company owns (on the left hand side), and what a company owes (on the right hand side). As the term “balance sheet” suggests, the total assets should match the total liabilities, what we own equals what we owe. A balance sheet shows you where you got the capital for the company (on the right), and what you have invested it in (on the left).
The income statement, or profit and loss statement, is an overview of how much a company has earned during a period. Some companies use the terms revenue, expenses and profit. Others use sales, costs, and earnings or income. If your revenue is bigger than your expenses, you make a profit. If expenses are bigger than revenue, you make a loss.
The way to remember these easily is to think of the balance sheet as a picture at a point in time, and the income statement as a movie about a certain period.
Let’s put the balance sheet and income statement side by side, starting with a blank sheet. We will make some simple journal entries to show the relationship between balance sheet and income statement.
If we start a company, we need to raise capital. The certificates of ownership that we give to shareholders are called equity, and they send us cash. Our company now owns a cash balance (on the left), and owes equity to the shareholders.
Then we might apply for a loan from the bank. When we sign the loan agreement, we are in debt to the bank. In return, we receive cash.
With the money we raised, we buy Plant and Equipment, in short P&E, or fixed assets. A building and some machines. We now own the Plant and Equipment, and in return for getting the keys to the building and the keys to a forklift truck, our cash is reduced.
We order inventory from a supplier. The delivery truck brings you the inventory (another asset, something you now own), and you receive an invoice from your supplier that you have not paid yet (accounts payable, you owe money to your supplier).
So far, we have only touched the balance sheet, growing both what we own and what we owe. Let’s record some costs or expenses. We receive an interest charge related to the bank loan, and pay it in cash. We account for the usage (value deterioration) of the Plant and Equipment through a depreciation entry. We record salaries (compensation and benefits) for the staff in our shop, and pay them in cash.
Then we finally make our first sale. Note that this took quite a while after starting the company. For the sales transaction, we record the invoicing of the revenue, and the claim to future cash (accounts receivable) from our customer. We also record the shipment of the goods to the customer, and the related Cost of Sales.
Then we can calculate subtotals: Gross Profit, Operating Profit (or EBIT Earnings Before Interest and Tax), Profit Before Tax. We record the tax charge of 20% of the EBT, paying it in cash. And then, to finish off the income statement, we calculate Net Income.
Now we seem to have a problem. Our balance sheet does not balance. Our assets are bigger than our liabilities. What are we missing? This is where we need to remember that the balance sheet is a picture at a point in time, and the income statement is a movie about a certain period. We need to somehow connect the picture and the movie. To do that, we add the net income earned during the year to the balance sheet of the end of the year. Interest is the reward for the bank for granting us a loan. Net income is the reward for the shareholders for making risk-bearing capital available. We add the Net Income earned during the year to Equity, in a sub-account called Retained Earnings. And the balance sheet balances!
That’s how the balance sheet and income statement fit together.
Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business and #accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investing decisions. Philip delivers #financetraining in various formats: KZbin videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

[@TheFinanceStoryteller]

Enjoyed this video? Then subscribe to the channel right now, and let's go into much more detail on how to read an income statement: kzbin.info/www/bejne/fqKQZWeGfcx0n7c

[@aries3690]

Thank you, my teacher is soo trash, especially during online classes for quarantine. You saved my marks!

[@TheFinanceStoryteller]

Happy to help! Maybe the videos in my "Accounting 101" playlist can also be helpful to you: kzbin.info/www/bejne/hYrUnWqPbrOheMk

[@sahrisahil713]

Never say trash to any teacher

[@aries3690]

@@sahrisahil713 Ok boomer

[@resikin]

@@aries3690 Oh God, this comment is cringe.

[@mavericksubarjan2669]

As a student, i do agree some teacher are bad. Like I'm not paying my hard earned money for understanding nothing.

[@ruslanivanov2689]

Sir, this is the most clear explanation of the BS and P&L relation that I have ever seen. I work in finance, but my work and experience has been always focused on the P&L, so I lack real knowledge of the BS. Your videos are extremely helpful for refreshing the knowledge. Thanks!

[@TheFinanceStoryteller]

Hello Ruslan! Thank you very much for the kind words. Yes, in the various finance roles that I have done in the past, the focus was also mostly on the P&L. Now that I teach finance and business, I discover the value of the balance sheet as well as the cash flow statement more and more. Here's a tutorial on the balance sheet (Walmart case study) kzbin.info/www/bejne/m3rNdJSbg9JgjM0 and a few examples on why profit and cash flow from operations are not always the same number: kzbin.info/www/bejne/iYmZpXevbL6DncU Enjoy, and let me know what you think!

[@yadagiriibusetty3025]

Well explained...Easy to understand for all who is not from financial background.

[@TheFinanceStoryteller]

Thank you, Yadagirii! That is very nice to hear. Please subscribe to the channel, I hope you find many more useful videos. Here's one that I would recommend, around 5 "Big Ideas" in the finance field: kzbin.info/www/bejne/n4Oak2WEn8x0hZo and you go from there to other videos of interest through the links/endscreen.

[@Zoliman]

This answers exactly what I didn't get before. Thanks a lot!

[@TheFinanceStoryteller]

Happy to help! Once you see the interactions between these two financial statements, the logic of double entry accounting makes a lot more sense.

[@playwithvayofficial]

Very good video, thanks a lot! This is very clear and precise to comprehend as opposed to other similar channels out there. Much appreciated and keep up the great work.

[@TheFinanceStoryteller]

Thank you very much, Vay! I have a few examples of how to analyze income statement and balance sheet for real-life companies on my channel. These might be helpful for you as well. Enjoy!

[@loganyang619]

Thank you, you are much better than my accounting lecturer!!

[@TheFinanceStoryteller]

Wow, thanks! And congrats to you for finding additional resources like my KZbin channel to help you move forward in your education. Please share the link to the channel with your fellow students.

[@kauabarros9638]

Learned more in this Fidetham my entire High school career. Thanks chief 🤙🏾🤙🏾🔥

[@TheFinanceStoryteller]

Thank you for the kind words, Kaua! Hope you find many more useful videos on this channel. If I may give a suggestion, take a look at my video explaining the balance sheet: kzbin.info/www/bejne/m3rNdJSbg9JgjM0

[@omarzeyad1382]

I'm doing MBA degree but still visiting this channel, especially when it comes to my weakness calculus and finance. really thank you so much !

[@TheFinanceStoryteller]

Thank you so much, Omar! You can do it! :-) Please spread the word to your fellow students. Having a solid grasp of accounting logic will benefit you in any leadership role. Hope you find plenty of useful information on my channel.

[@Malayamakiya]

Do calculus is play some rule in finanacing??

[@mingyangwang2600]

This is really helpful! Thank you so much!!

[@TheFinanceStoryteller]

You're welcome! Thank you for commenting, it's nice to get feedback.

[@natalia______8996]

Thank you so much for this video. It was really helpful. I’m getting ready for the interview. Refreshing my memory.

[@TheFinanceStoryteller]

Glad it was helpful! Wishing you lots of success with the interview!

[@domdompomodoro6621]

Excellent simple explanation. Thank you.

[@TheFinanceStoryteller]

Good to hear that! Thank you. When I deliver "finance for non-financial managers" training, I start off my sessions with this exercise.

[@gergobmx91]

great refresher in less than 5 minutes, well done

[@TheFinanceStoryteller]

Thank you, Gergo!

[@ericbess584]

Thank you...it was the pieces of the puzzle I was missing

[@TheFinanceStoryteller]

You're welcome! Happy to hear that. :-)

[@zmongi1]

Thank you for this!

[@TheFinanceStoryteller]

Thank you, Zach!

[@lachoranchev6039]

Awesome vid - made a lot sense! Thanks Can you do similar vids how balance sheet interact with cash flow statement and income statement with cash flow statement? If you have those already please provide links

[@TheFinanceStoryteller]

Thank you! Happy to hear you enjoyed it. I do have a short video on how the three financial statements relate: kzbin.info/www/bejne/e5vJqpl6qragms0 and a video that explains with some short practical examples the difference between net income and cash flow from operations kzbin.info/www/bejne/iYmZpXevbL6DncU and a video that explains how to go from net income to cash flow using the indirect method kzbin.info/www/bejne/aKXVkGl6Z7h4adk

[@anlozturk6571]

This video saved life

[@TheFinanceStoryteller]

Wow. Good to hear it was useful. Related videos in this playlist: kzbin.info/www/bejne/e5rFmpWMe6qerM0&pp=gAQBiAQB

[@Diljeet_-singh]

Great information. Thank u 🙏💕

[@TheFinanceStoryteller]

You're welcome! Happy to hear you enjoyed it.

[@erickwalsh9258]

Amazing!! So clear

[@TheFinanceStoryteller]

Wonderful! Happy to hear that.

[@samuelong3804]

finally understand this topic, thank you!!

[@TheFinanceStoryteller]

That is wonderful to hear, Samuel!!! Thank you for watching and commenting. Hope you find many more videos on the channel that are useful to you.

[@samuelong3804]

@@TheFinanceStoryteller many many more to be watched and understood, sir!

[@angelosenlob1557]

good and clear, with numbers !

[@TheFinanceStoryteller]

Thank you, Angelo! Happy to hear that.

[@nicaciogilson7179]

Excellent explanation! Thanks

[@TheFinanceStoryteller]

Happy to help!!!! :-)

[@myomyo4779]

Really Thank You!

[@TheFinanceStoryteller]

You're welcome!

[@mariacostardi1238]

Thank you very much!!

[@TheFinanceStoryteller]

You're welcome, Maria!

[@yasirhussain3217]

Very easy n helpful. Thanks sir

[@TheFinanceStoryteller]

Thank you very much! Nice to hear that!

[@Dan-fz4zv]

Thank you so much for this

[@TheFinanceStoryteller]

You're so welcome! Happy to help.

[@Cmac13]

Thanks bro. Clutch

[@TheFinanceStoryteller]

No problem 👍

[@akramtaoussi2390]

Thanks for your explanation 🙏🏻🤍🥺

[@TheFinanceStoryteller]

Happy to help, Akram! 😊

[@mariacostardi1238]

This video is awesome!!

[@TheFinanceStoryteller]

Nice to hear that! I have used this example many times with groups of participants for "finance for non-financial managers" courses. Once you understand the interactions between these financial statements, it's good to go into more depth for the income statement kzbin.info/www/bejne/fqKQZWeGfcx0n7c as well as the balance sheet kzbin.info/www/bejne/m3rNdJSbg9JgjM0 or dive into specific terms that you want to learn more about like revenue kzbin.info/www/bejne/bmKZgmmmhMZ6rJY

[@romixfox4287]

Suer clear and easy to understand

[@TheFinanceStoryteller]

Thank you! Very nice to hear that. :-)

[@user-xi9hi8zl6z]

Wow, thank you so much sir

[@TheFinanceStoryteller]

Happy to help!!!

[@ShahrukhKhan-kl8vo]

This lecture is Bravoo

[@TheFinanceStoryteller]

Thank you!!!! The interrelationships between balance sheet and income statement are very important to understand.

[@vanessaalexander1902]

would you include things like income expenses, rent expenses, interest expenses or insurant expenses in a balance sheet?

[@TheFinanceStoryteller]

Hello Vanessa! No, those would go into the income statement. Here's a link to a tutorial on how to read an income statement: kzbin.info/www/bejne/fqKQZWeGfcx0n7c

[@ronnieeaton5514]

This is fantastic

[@TheFinanceStoryteller]

Thank you! Please spread the word!

[@andrewotemba533]

Thank you

[@TheFinanceStoryteller]

You're welcome

[@KrishanSingh-gz9op]

1.I have read some articles which says that losses are shown on the asset side of the balance sheet !! 2. And i also know & have seen in companies balance sheets that losses are subtracted from retained earnings. I am confused about the first statement, are both the statement true? Arent we double counting the effect of loss if we follow both the statements?.

[@TheFinanceStoryteller]

I agree with statement #2: see my video on retained earnings kzbin.info/www/bejne/rpragptrepx9jbM The only way I can make sense of statement #1 is that you could have (for example) an impairment of goodwill or intangible assets, uncollectable receivables, obsolete inventory - all of these are occurring on the assets side of the balance sheet, lead to a charge in the income statement, and could lead to a company making a loss (negative profit) in a certain quarter or year. See also my video on asset impairment: kzbin.info/www/bejne/ooiwdZeqfatnkLc

[@KrishanSingh-gz9op]

@@TheFinanceStoryteller i found first statement when i was studing about internal reconstruction.

[@isaacgutierrez6036]

so usefull dude

[@TheFinanceStoryteller]

Glad to hear, Isaac!

[@AzuVincent-oy1ez]

I enjoyed the video 😍

[@TheFinanceStoryteller]

Happy to hear that! Thank you.

[@derffgggdf]

Sir will you plz bring more videos ? Or explan in detail? ❤️👍

[@TheFinanceStoryteller]

Working on some new ones! In the meantime, feel free to browse through the existing library.

[@derffgggdf]

Ok thank u 😉❤️

[@Malayamakiya]

Does The balance amount of balance sheet show the something our it is just for checking a mathematical accuracy.

[@TheFinanceStoryteller]

It's the fundamental idea behind the double entry accounting system (assets = liabilities + equity) plus the balance sheet totals tell you something about the size of the company. Here's the link to my balance sheet tutorial, walking through the statement for a real life company: kzbin.info/www/bejne/m3rNdJSbg9JgjM0

[@Malayamakiya]

@@TheFinanceStoryteller thank you 👍

[@TheFinanceStoryteller]

@@Malayamakiya Thank you for watching and commenting!

[@monirahmed5483]

why net loss includes in balance sheet as asset side?:

[@TheFinanceStoryteller]

Hello Monir! In the example in this video, the company makes a profit, which is not distributed to shareholders. Therefore, it is added to the retained earnings account in the equity section of the balance sheet. If the sum of the accumulated profits and losses is a positive number, then the retained earnings account shows a positive balance. If the sum of the accumulated profits and losses is a negative number, then the retained earnings account shows a negative balance, and becomes a "contra equity account" (NOT an asset): kzbin.info/www/bejne/n6nOlamFiZyNeqs

[@youtubechannel0107]

Nice

[@TheFinanceStoryteller]

Agree! 😉

[@abdelhadiredouane4973]

The channel must = 10 milion subscribers

[@TheFinanceStoryteller]

I agree! Please tell all your friends. 🙂

[@spikeyspike79]

all good, but equity should not have been labelled as a subcategory of liabilities but stands on its own as the third component of the BS such that A = L + E, or A - L = E...

[@TheFinanceStoryteller]

Correct. It took me a while to figure out that the English language lacks a word for the right-hand side of the balance sheet. In French, it is called "les passives", in German "die Passiven", in many other languages a variation thereof. Only in English is it "liabilities and equity".

[@yasirhussain3217]

I have one question about quicks book. I want to add one hidden column in sale invoice as cost column... Which can be seen by our company n every time I can change the figures of both sale service N cost service. Can u help? But in print not showing cost column

[@TheFinanceStoryteller]

Sorry, but I have never used Quickbooks in my life, so I cannot help you on that question...

[@ExpatJoel]

at 0:39 , thats wrong. Total assets, do not equal total liabilities. Total assets equal total liabilities PLUS equities

[@TheFinanceStoryteller]

Thanks for the feedback, Joel! It is a problem in the English language. Sometimes the word "liabilities" is used to indicate the whole right-hand side of the balance sheet (the "broad" use), at other times it is used to only indicate money owed to creditors (banks, suppliers, etc. - the "narrow" use). You are correct that in the "narrow" sense of the word, the accounting equation states that assets = liabilities + equity. As far as I know, there is no separate word in English for the right-hand side of the balance sheet. In French, for example, the left-hand side is called "les actives" and the right-hand side "les passives", there is no equivalent for that in English.

[@dontaskme9778]

Today is my Viva 🥺

[@TheFinanceStoryteller]

Wishing you lots of success!!!

[@dontaskme9778]

@@TheFinanceStoryteller that was great 5/5 yuppe 😆

[@anthonygirdler606]

Don't understand why owned = owed. For example, business buys a truck and borrows 100,000. We owe 100,000. Let's say we pay interest only on the truck. After 5 yrs we still owe 100,000 because we didn't pay off any principle. The truck has been treated poorly and is now only worth 50,000. Doesn't "balance" and you wouldn't expect it to. Balance sheets make no sense.

[@TheFinanceStoryteller]

Oh yes, it does balance. Initially, in your example you have 100K in assets and 100K in liabilities. Then you start using the truck (incurring depreciation) and you need to account for the interest on the loan as you correctly stated. Using your numbers, we record 10K per year in depreciation of the truck, and let's say 5K in interest expense per year. Those 15K in total are expenses in our income statement, that end up in retained earnings (part of equity) at the end of the year on the balance sheet. So if this is all the business has (which is very unlikely, hopefully you also generate some revenue from selling something), and forgetting about taxes at the moment (let's not make the example too complicated) then at the end of year 1 we have 90K in assets (100K purchase price of the truck minus 10K depreciation), in liabilities 105K in borrowings plus interest owed, and equity -15K (sum of depreciation expense and interest expense). At the end of year 5: 50K in assets (per your example: 100K purchase price minus 5 times 10K in depreciation), liabilities 125K (100K + 5 times 5K interest owed), and equity -75K (5 times 15K expenses per year). Now having that kind of significant negative equity would make you bankrupt, and the bank probably will have repossessed the truck by that time. Does that help?

[@WaiKoH]

My lecturer confused me so bad, she went on and on for 2hr's about something that could be explained perfectly in 4 mins. Why did she make it so difficult, I don't get it

[@TheFinanceStoryteller]

Sorry to hear that, Robbie! It's a good thing that you went out to find additional information on this, hope you get it now. Maybe you can teach the topic back to her. ;-)