The income statement documents the accounting aspects of a company’s sales, production and operations. Companies generate immediate cash or accounts receivable and reduce inventory when they sell their products or services. However, fluctuations in accounts receivable generally do not affect the income statement. Changes in inventory levels also do not impact the income statement, but changes in the inventory's cost basis do.
Accounts receivable, or A/Rs, are amounts due from customers as payments for goods or services your company provides. You create an account receivable when you mail an invoice to a customer. A/Rs are listed on the balance sheet as short-term or current assets. Inventory is merchandise or items held for sale, the materials used to produce salable items or items in the process of being made. Inventory is also included in current assets.
Since accounts receivable and inventory are balance sheet items, they do not directly affect your company’s income statement. Fluctuations or changes in these two current assets always appear on the balance sheet and on the cash flow statement. Revenues on the income statement show up as A/Rs or cash on the balance sheet and cash flow statement. The payment of A/Rs by customers converts A/Rs to cash, which in no way impacts the income statement.
As your company sells products, it reflects its inventory costs in the cost of goods sold line item on the income statement. Therefore, any fluctuations or modifications to the cost basis of that inventory will impact the income statement via the cost of goods sold. However, as with A/Rs, the cost of goods sold on the income statement already reflects inventory valuations on the balance sheet, so inventory-level fluctuations do not affect the income statement.
The balance sheet shows your company's assets, liabilities and owner's equity at a particular point in time. On the balance sheet, assets plus liabilities equal net worth or owner's equity. This means the valuable items your company owns less what debts and obligations it owes must equal what your company owes to you and any other owners and investors.
The income statement records your company's operational performance over a specific time span or period. Your company exists to generate revenue and earn a profit that benefits you as an owner, and the income statement records how effectively your company did so. It shows your company's sales, expenses and profits. The net income, shown at the bottom of the income statement, indicates your company's level of profitability.
Any inventory losses or uncollectible A/R write-offs may impact the income statement. Uncollectible A/Rs will appear as a bad debt expense on the income statement. Inventory lost to theft or fire will usually show up as a cost of goods sold adjustment, but for sizable losses, many companies prefer to include the loss as a miscellaneous expense on the income statement.
