What is the Relationship between the Profit and Loss Statement and the Balance Sheet?

What is the Relationship between the Profit and Loss Statement and the Balance Sheet?

If you want to analyse the financial statements of your business efficiently, you need to have an in-depth understanding of the relationship between different financial statements. However, it may be challenging for you to discover those relationships. In the annual financial report of your company, you will see every financial statement on a different page, yet you will never find their interconnections in this report. Hence, as the business owner, the methods you want to use to analyse them is at your choice, for example, by using the financial ratios. Let us have a look at the article below and find out the connections between the profit and loss statement and the balance sheet of your business.

If you implement the double-entry accounting (Also see Common Concepts in Accounting) when recording an expense or a sale, you will probably discover the relationships between the profit and loss statement and the balance sheet. Keep in mind that when the sales increases, there will be an increase in your assets or a decrease in your liability. On the contrary, when you incur an expense, your assets tend to decrease while your liability tends to increase.

This means that you will need to record one side of every sales or expense entry in the balance sheet, and you need to record the other side in your profit and loss statement. Hence, you can see that there is a close relationship between the balance sheet and the profit and loss statement, yet you need to report the figures separately.

For you to get a better understanding of the interconnections between the balance sheet and the profit and loss statement, you should consider the points listed below:

– The credit sales that you record in your profit and loss statement will create accounts receivables (Also see What Are Accounts Receivables and Bad Debts?) in your balance sheet.

– Your company must own inventories (which is the stocks that you record in your balance sheet) if you want to make sales (which you will record in the profit and loss statement)

– If you intend to obtain inventory, you probably will need to purchase the goods on credit. This will result in accounts payable.

– You will need to record depreciation in the balance sheet as well as the accumulated depreciation contra account in your profit and loss statement.

– In your balance sheet, you will see the operating expenses, which refers to various selling, administrative, as well as general expenses. At the same time, you will see these expenses in the accounts in your balance sheet, which includes the accrued expense account (Also see Where Should You Record the Accruals on Your Balance Sheet?), accounts payable, and so on.

As you can see from the relationships between the balance sheet and the profit and loss statement mentioned above, every income or expense that you record in the profit and loss statement will show up in your balance sheet. Thus, here comes a new question: Are balance sheet and the profit and loss statement the same?

The balance sheet shows the finances of your company at a given time. It reveals three essential items, which are the assets (Also see How Do Tangible Asset and Intangible Asset Differ from Each Other?), liabilities and owner’s equity of your business. On the contrary, the profit and loss statement reveals the income and expenses of your company over a period. The main objective of this document is to calculate the amount of cash flow your business has generated or the loss your company has suffered from in a certain period.

If accounting is not your thing, you can consider employing an accounting firm in Johor Bahru so that you can get assistance from the professionals.