Balance sheet and income statement are two of the most used as well as important financial statements as far as company is concerned and any person whether its creditors of the company, debtors of the company, employees of the company, government, shareholders of the company depend on these two statements for making any conclusion regarding the performance of the company during a financial year. In simple words balance sheet and income statement are similar to heart and brain of human being just like human beings are dependent the most on these two for proper functioning of the body in the same way external as well as internal people are dependent on balance sheet as well as income statement for knowing about the financial position of the company.
Income statement comprises of various incomes as well as expenses made by the company during the financial year, hence things like net sales, operating expenses, administrative expenses, marketing expenses, taxes and so on are included in the income statement while as far as balance sheet is concerned it comprises of share capital, reserves, creditors, debtors, cash balance and so on.
The relationship between balance sheet and income statement is a strong one because any item which affects the income statement in the current year is bound to affect the balance sheet of the current year and any change in balance sheet item will have an impact on the income statement of the next year. Hence for example if company has paid more salary or there is an increase in expense in income statement than it results in lower net profit which in turn results in fewer reserves in the liability side as net profit of the current year stands reduced, similarly if company has taken additional borrowing from bank then it will not increase the liability side of the balance sheet but also it will lead to higher interest payment in the next year thus increasing the expenses in the form of higher financial cost on the payment or expense side of income statement.
As one can see from the above that both balance sheet, as well as income statement, are highly correlated with each other and any inconsistency between the two should be carefully looked into, hence for example if company has taken bank borrowing of $100000 at 10 percent and in income statement company is showing only $5000 as interest on the expense side than it implies that something is wrong. In short, anyone looking to analyze the financial statements of the company should closely look at both the statements in order to get a better idea about the financial position of the company.