What is the Balance Sheet?

A balance sheet lays out the ending balances in a company's asset, liability, and equity accounts as of the date stated on the report. As such, it provides a picture of what a business owns and owes, as well as how much as been invested in it. The balance sheet is commonly used for a great deal of financial analysis of a business' performance.

What is the Income Statement?

The income statement presents the financial results of a business for a stated period of time. The statement quantifies the amount of revenue generated and expenses incurred by an organization during a reporting period, as well as any resulting net profit or net loss.

Connection Between the Balance Sheet and Income Statement

There are several connections between the balance sheet and income statement when double-entry accounting is used. These connections are as follows:

Net income affects equity. The net income (or net loss) from the income statement is added to the retained earnings section of the equity portion on the balance sheet. Retained earnings increase with net income and decrease if there is a net loss or dividends are paid.
Revenues and expenses relate to assets and liabilities. Revenues from the income statement often correspond to an increase in assets (e.g., cash or accounts receivable). Further, expenses often correspond to an increase in liabilities (e.g., accounts payable) or a decrease in assets (e.g., cash).
Depreciation and asset valuation. Depreciation expense from the income statement reduces the book value of fixed assets on the balance sheet.
Dividends. Dividends declared and paid do not appear on the income statement but reduce retained earnings on the balance sheet.

Example of the Balance Sheet and Income Statement Connection

Big Apple Produce sells several bushels of apples for $1,000. This is recorded as revenue on its income statement, and increases shareholders’ equity on the balance sheet by the same amount. Big Apple then pays the daily wages of a warehouse worker, which appears as a $200 expense on its income statement and reduces shareholders’ equity on the balance sheet by the same amount. Finally, the company finds that one bushel of apples is rotten, and writes off its value; this is a $40 loss on the income statement and a $40 reduction of shareholders’ equity on the balance sheet.