A lot of transactions go through the balance sheet. Let's say a business enters into a transaction. That transaction will have at least two effects on the balance sheet formula assets equal liabilities plus equity. The question mark is what actually happens? Let's have a look at some examples. Here we have a number of transactions. Let's go through the top three. The first one says that the company issues shares for cash. I want to see how this impacts my balance sheet formula, assets equal liabilities plus equity. Well, if they've issued the shares for cash that means your cash is going to go up, and the left hand side of your formula assets goes up. Remember, the balance sheet formula must balance, so that means the right hand side probably has to go up as well. And I know that equity is going to go up, in particular, their capital line will increase.

In our next transaction, a loan is taken out. Let's assume that is cash that's received. So, cash goes up. Again, I need to work out how to balance the formula. So, I look at my liabilities. If a loan is taken out, that means some debt has gone up.

The left hand side of the formula has gone up. The right hand side of the formula has gone up. That loan line taken out, that balance is perfect. Last one here, a car is purchased for cash. Well, a car that's going to be an asset. That's going to sit within your PP&E, your property, plant and equipment line. That's going to go up, fantastic. However, your cash has been spent. Your cash has gone down. So, now cash down.

So, what's happened overall, your assets have gone up with PP&E and down with cash. So the two of them offset, and so assets haven't changed. The right hand side of the formula hasn't changed either.

The income statement can be seen to integrate with the balance sheets. Let's focus on the bottom right hand corner, the equity box. Within this, there's an item called retained earnings. And retained earnings shows accumulated profits not paid out to shareholders as dividends. Now, profits is the key word there. Where do we measure profits? Well, we measure profits on the income statement. The income statement shows your sales less associated expenses with those sales. So that gives you your profit if we assume no dividends paid. It's all reinvested, and that all goes into the balance sheets. So, we can say that the income statement explains the change in retained earnings. We want to see the two of these coming together, so let's see some transactions that go through the income statements and affect the balance sheets.

Here we have a number of transactions, and these may impact the income statements and balance sheets. Let's start with the first one. We pay the window washer with cash. Now the window washer that's an expense that's going to hit the income statements. If we're paying them with cash then that means my cash on the balance sheet will go down. Cash goes outta the business. And if the window washer is an income statement item, how is that going to affect the balance sheets? Well, the window washer is an expense on the income statements, and if an expense on the income statement goes up, that means your profit on the income statement goes down, boo. But, if your income statement profit has gone down, that means that your retained earnings on the balance sheet will also go down.

You've got less profits, less profits reinvested in retained earnings. That means my balance sheet formula now balances. Phew.

A water bill arrives and is not paid. Well, a water bill, that represents a liability, and that means my accounts payable will go up, accounts payable where I owe a supplier.

The water bill again, that's an income statement item, and that's an expense for the period, but how is that going to affect my balance sheet? Well, again, an expense going up means my income statement expenses go up, and my income statement profit goes down. Oh dear. Retained earnings goes down again, but phew, my balance sheet formula again balances. The right hand side saw an increase, and the right hand side saw a decrease. Nothing happened on the asset side at all.

Let's just finish up the water bill. Two weeks later, the water bill is paid in cash. Well, again, that's going to mean cash goes down, and it will make my accounts payable go down as well. Notice it only hits the income statement when the bill was received, so that my water bill only affected the income statement or retained earnings when it was received. The fact that we actually pay it two weeks later didn't affect the income statements. It didn't affect retained earnings. So, we can see that when we have transactions that affect the income statements, they still affect the balance sheet, and we still have to make sure that our balance sheet formula balances.