Question

Relationship between Balance Sheet and Income Statement Accounts

Sales & A/R

COGS & A/P & Inventory

Answer 1

The Relationship Between Balance Sheet & Income Statement Can be explained Below with an illustration.

The Balance Sheet reports a company's assets, liabilities, and owner's equity as of the last instant of an accounting year. Generally, the amount of the owner's equity will have changed from the previous balance sheet amount due to
•   the company's net income
•   the owner's additional investments in the business
•   the owner's withdrawals of business assets
If the owner did not invest or withdraw, the change in owner's equity is likely to be the amount of net income earned by the business. The revenue expenses, gains, and losses that make up the net income are reported on the company's income statement.
To illustrate, let's assume that a company's balance sheets had reported owner's equity of $40,000 as of December 31, 2012 and $65,000 as of December 31, 2013. If during the year 2013 the owner did not invest or withdraw business assets, the $25,000 increase in owner's equity is likely to be the net income earned by the business. The details for the $25,000 of net income will appear on the company's income statement for the year 2013. (If the owner had withdrawn $12,000 of business assets for personal use, the net income must have been $37,000 since the net increase in owner's equity was $25,000.)
The connection between the balance sheet and the income statement results from the use of double entry accounting or bookkeeping and the accounting equation
Assets = Liabilities + Owner's Equity.

We can calculate return on Net Assets based on the income statement & Balance Sheet. The formula is as follows.

Return on Net Assets = Net Income / ( Fixed Assets + Net Working Capital)

Relationship Between Sales & Accounts Receivable.

The Accounts Receivable to Sales Ratio is a business liquidity ratio that measures how much of the company’s sales occur on credit. When a company has a larger percentage of its sales happening on a credit basis, it may run into short-term liquidity problems. Such a scenario may happen if a company is running low on cash due to the lack of cash sales in the business cycle.
The Accounts Receivable to Sales Ratio is also useful in evaluating how inclined a company is to conduct business on a credit basis, which can shed insight into its operational structure. A company that is able to run with little cash may have very small fixed costs or a low amount of debt in its capital structure.
Nonetheless, a company with a very high AR to Sales ratio can be a negative indicator to debt providers, since it may compromise a company’s ability to make periodic interest payments. Furthermore, a very high ratio indicates that a company may not have much of a cash cushion to rely on during difficult economic times and slow sales cycles.

The Liquidity Ratio (or) Quick ratio (or) Acid Test Ratio can be measured with the following formula

= (Cash Equivalents +Marketable Securities + Accounts Receivables) / Current Liabilities

Relationship between Cost of Goods Sold & Accounts Payable & Inventory.

Inventory for a retailer or distributor is the merchandise that was purchased and has not yet been sold to customers. For a manufacturer, Inventory consists of raw materials, packaging materials, work in process and the finished goods that are owned and on hand. Inventory is generally valued at its cost. If a business has inventory it is often a major component of its current assets.

The cost of goods sold is the cost of the merchandise or products that have been sold to customers during the period of the income statement. For a company that sells goods, the cost of goods sold is usually the largest expense on its income statement. As a result, care must be taken when computing and matching the cost of goods sold with the sales revenues.

To illustrate how inventory and the cost of goods sold are connected, let's assume that a retailer carries only one product. It has 100 units of the product in inventory at the beginning of the year and purchases an additional 1,500 units during the year. Accountants refer to the combination of the beginning inventory plus the purchases for the period as the goods available for sale. Which in this example is 1,600 units. If there are 125 units on hand at the end of the year, the ending inventory will report the cost of 125 units. The cost of goods sold for the year will be the cost of the 1,475 units that are no longer available.

If the per unit costs of the products (or inputs) change during the year, the company must follow a cost flow assumption [FIFO, LIFO or average] in order to divide the cost of goods available for sale between the ending inventory and the cost of goods sold.

Both accounts payable, and inventory are listed on a business's balance sheet. Even though inventory is a cost, it falls under assets on the balance sheet. Accounts payable to purchase the inventory is shown as a liability on the balance sheet. Together, the assets and liabilities show the business's financial standing on a day-to-day basis. It shows how well you are managing your inventory and which supplier may be inclined to provide additional credit for more inventory because of satisfactory payments.

A business may extend credit terms to its clients for customer flexibility. To help a business manage its payments, a supplier may provide credit terms, which may allow a business to pay for its inventory over a period of weeks. A business can calculate its inventory and payable ratio by taking the ending accounts payable from inventory purchases against the inventory at the end of the accounting period. If the inventory is too high, the business may need to take steps to boost sales.

A business should keep a close watch on both accounts payable and inventory. Inventory can tie up money. If a business is investing too much money in inventory that is not turning over, the lack of sales revenue can put the business in the position of not being able to pay its accounts payable to its supplier according to the agreed terms which could result in the loss of a supplier or a poor credit rating.