How do the income statement and balance sheet connect?

The connection between the income statement and the balance sheet is fundamentally established through net income and cash balance. Net income generated on the income statement reflects the company's profitability over a period, and this figure has a direct impact on the equity section of the balance sheet.

When a company earns profits, that net income is added to retained earnings in the equity section of the balance sheet. This retained earnings increase reflects the cumulative profits that have not been distributed as dividends. Additionally, the cash balance can also be influenced by net income, as a portion of the net income may be reflected in cash flows. While net income is also integral to cash flow statements, the link to retained earnings ties it directly to the balance sheet.

This understanding highlights how performance (as depicted in the income statement) ultimately influences the financial position of a company on the balance sheet, making it crucial for assessing the health and efficacy of the business over time.