What Is the Relationship between an Income Statement and Balance Sheet?

The income statement and balance sheet are two types of accounting documents that may be used by any organization. These two reports are particularly prevalent in the United States because the official forms of the documents, by law, must be regularly filed with the U.S. Securities and Exchange Commission. Information from the income statement is used to create retained earning statements, balance sheets, and statements of cash flows.

Income statements, sometimes known as earnings statements or statements of operations, list a company’s expenses and revenues for a specific period of time. The record also presents the net loss or gain in capital resulting from the expenses and revenues. When revenues are higher than expenses, the company has had a net gain, or made a profit, over the span of time listed on the income statement. Expenses exceeding revenue indicates that the company has suffered a net loss of funds.

Instead of covering a span of time like the income statement, balance sheets provide accounting information for a single point in time. Generally, accountants keep ledgers, which are informal records of the company’s economic events. The accountant organizes these events using the fundamental accounting equation, which is assets plus liabilities equal stockholders equity. Balance sheets list the ending sums of assets, liabilities, and equity for a particular date.

Information on the income statement is used to create the balance sheet, but that information is first filtered through a retained earnings statement. The process begins with the accountant transferring the income statement’s balance, or deficit depending on the circumstances, to the retained earnings statement. On the retained earnings statement, the accountant subtracts the dividends from the transferred net income or loss. The result is the retained earnings, which is listed under the Liabilities and Stockholders’ Equity column of the balance sheet.

Cash assets listed on the balance sheets are used to create statements of cash flows. Along with the income statement and balance sheet, the retained earnings statement and the statement of cash flows make up the four basic accounting statements. Business leaders, investors, and U.S. government officials use the income statement and balance sheet, as well as other documents, to study a company’s business operations and determine its overall financial health. Several calculations and financial ratios may be determined using the numbers on these statements, including debt-to-equity ratio and the company’s operating margin.