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When we are talking accounting, most people know of their Profit and Loss or Income Statement and their Balance Sheet. Most people are even aware that you should be looking at these and understanding them on a regular basis to help understand their business financially and grow the business. But many people do not realize how interconnected these reports are, and while there are many differences, there are many interlinked accounts. Some are obvious as they are direct carryovers. However, even your liability and asset accounts are ultimately interconnected in ways.
The most apparent link comes from your Net Income, which should directly port over from your Profit and Loss to your Balance Sheet. The Net Income on your Balance Sheet, though, will be an accumulation of all income for the entire tax year. In contrast, the Net Income on your Income Statement will be regulated by the date range you have filtered your Income Statement by. This may lead to these two numbers not directly correlating as it pulls from two different periods. However, for someone using a standard tax year, January 1st to December 31st, a Profit and Loss pulled in year-to-date should exactly match your Balance Sheet net profit if it is in the same accounting basis, cash v. accrual.
Moving up the Balance Sheets, your long-term liabilities will also pass through over to your Profit and Loss in two key areas. First will be your long-term liabilities with loans and mortgages. As you pay these loans off, part of the payment pays down the principle or the long-term liability on your Balance Sheet, while the other portion is expensed as interest. Every month this long-term liability is directly interacting with your Profit and Loss to record the interest expense and keep the liabilities balance accurate for you throughout the loan term. Your payroll taxes and benefits payable will all directly integrate together outside of long-term liabilities. As you pay in your portion of Social Security or Medicare, that is an expense on your Profit and Loss, but it is not money you are spending today. It is money that you will spend down the road at the beginning of the next month, quarter, or year hence why it is sitting as a liability. While what you are withholding from an employee is recorded as wages, your contribution is a direct expense out of your books for taxes. The same goes for employee benefits. Your share of health insurance or your 401K match all are benefit expenses on your taxes and is money that every pay period you need to set aside as a liability owed to pay out the next billing period. While these are two good examples, there are many other types of liabilities that can be connected as both an expense and a liability like Accounts Payable or Taxes Payable. As you will see in a moment, every expense ultimately will hit the Balance Sheet at least once.
Finally, as we close out the Balance Sheet with assets, your bank accounts are the biggest asset that connects both the Balance Sheet and the Profit and Loss. Every time you spend money, you reduce the balance in that bank account as an asset and record an expense on your Profit and Loss. Every time you make a sale and deposit money, you increase that asset and record income. Accounting is a function of debits and credits, and to increase sales or expenses you need to affect another account, and most of the time, these accounts are on your Balance Sheet either with your bank account, undeposited funds, or accounts receivable. Outside of the day-to-day operations, if you are tracking pre-payments on any expenses every month, those pre-payments reduce as you expense out a portion of that pre-payment. All of your fixed assets like vehicles, furniture, and tools all depreciate over time, and every year or month counts as a non-cash expense on your books by recording against your asset values on the Balance Sheet.
Ultimately due to the nature of accounting being debits and credits, almost every transaction will affect a Balance Sheet at least once by either increasing or decreasing that account as an asset or copying directly over from your Profit and Loss to help connect the accounting systems. This is why it is vital to not just look at a Profit and Loss every month and look at your Balance Sheet. Instead, it helps you understand how that profit affected you and where your company stands in terms of liquidity and cash flow to continue covering your expenses and planning your business growth!
