Balance sheet and income statement relationship | Finance & Capital Markets | Khan Academy

Let's see if we
can use our example to understand the three
types of income statements, and hopefully understanding
those income statements will also help us
understand this example. So I'm going to
start off– we're going to focus on month two. And what I have
done is I've just rewritten some of this accrual
income statement down here. So it really looks
like a statement. So this right here is
the income statement for month two on
an accrual basis. In that month, we
said we had $400 of revenue, $200 of expense. 400 minus 200 gives
us $200 of income. An income statement
tells us what happened over a period of time. What was the activity– how
much revenue, how much expenses, and other things. This is just a
super simplified one without taxes, without interest,
without other types of expenses over here. I also have drawn the balance
sheet at the end of month one and the balance sheet
at the end of month two.

Or you could also view
this balance sheet here as the balance sheet at
the beginning of month two. And the main thing to realize
is income statement tells you what happens over a time
period, while balance sheets are snapshots, or they're pictures
at a given moment– snapshots. So this tells us
essentially what did I have. The assets are the things that
can give me future benefit, so what do I have. And the liabilities
are things that I have to give future benefit
to, or things that I owe. So this is what I have. This is what I owe. And then the equity is what
I really have to my name if I net out the
liabilities from the assets. So at the beginning
of month two– which is the end
of month one– I had $100 of cash, no
accounts receivables. I didn't owe anyone anything. I didn't owe them money. I didn't owe them services. So 100 minus 0 means I had $100. That's kind of what the
owners of the company can say they have of value at
the beginning of the month. You fast forward– now
at the end of month two– I now owe the bank $100.

So I just put this as
negative $100 here. It normally wouldn't
be accounted that way on an actual
company's balance sheet, but this is simplified. But I have an accounts
receivable of $400. So my total assets now
are $300 of assets. And remember,
accounts receivables are an asset because
someone owes me something. Someone owes me
cash in the future. I still have no liabilities. So you take all of your assets,
minus all of your liabilities, and now I have $300 in equity. So you can see the
snapshot at the beginning of the month, 100 in equity. Snapshot at the end of
the month, 300 in equity. And so to go from one
point to the other, to go from 100 to 300, I must
have grown in equity by 200. I must have gotten $200 worth
of value from someplace. And that's what the income
statement describes. It describes it right over here. The change in equity,
sometimes it's the change in returned earnings
or just change in equity. That is going to be
the $200 in net income that the company got
over that time period.

Now, there's one thing
that you're probably confused by right now. It's like, well, how do
we reconcile everything with the cash? We know that over this
period we got $200 in income on an accrual basis. But when you look
at the cash, we went from $100 positive cash,
to negative $100 in cash. It looks like we lost $200. So how can we reconcile the
fact that we got $200 in income? How can we reconcile
that with the fact that we lost $200 in cash? And that reconciliation
is going to be done on the cash flow statement.

And I'll do that
in the next video..

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