The balance sheet provides a look at a business at a snapshot in time, often at the end of a quarter or year. In some cases, the accounts on the balance sheet -- assets, liabilities, and equity -- can also shed light into items that would normally be found on the income or cash flow statement.
With some additional information, it's entirely possible to calculate net income from assets, liabilities, and equity reported on a balance sheet. Here's how to do it under three circumstances.
1. No dividends were paid to the owner
When you know that a company didn't make a capital transaction such as paying dividends to the owners or receive cash for new stock sold, it's very easy to calculate net income from the balance sheet. All you need to know in this situation is the change in equity from one period to the next.
Suppose a company reports the following at year end 2014:
- Assets: $1,000
- Liabilities: $500
- Equity: $500
Now suppose it reports the following at year end 2015:
- Assets: $1,200
- Liabilities: $600
- Equity: $600
Knowing that there were no dividends paid to investors, nor any changes from the issuance or repurchase of stock, we can simply subtract the beginning period equity of $500 from the ending period equity of $600 to get net income of $100 for the 2015 year.
Logic follows that if assets must equal liabilities plus equity, then the change in assets minus the change in liabilities is equal to net income. That's assuming, of course, that there were no capital transactions in the equity account -- dividends to owners, or new investments by the owners.
2. The company makes dividend payments to the owner
If a company made one or many dividend payments to the owner, there is just one extra step in the process. You have to add the dividend back to the change in equity to arrive at net income for the year.
Suppose a company reports the following at year end 2014:
- Assets: $1,000
- Liabilities: $500
- Equity: $500
Now suppose it reports the following at year end 2015, after paying a $150 dividend.
- Assets: $1,200
- Liabilities: $600
- Equity: $600
We first have to calculate the change in equity. That is as simple as subtracting the beginning period amount of $500 from the ending period amount of $600, arriving at a $100 change in equity.
Now, when the company paid out a dividend, it resulted in a decrease in assets (cash, in this case) and a corresponding decrease in equity. While a dividend results in a decrease in assets and equity, it did not happen as a result of income. Thus, we need to add the $150 dividend back in to the $100 change in equity to arrive at net income of $250 during the 2015 year.
3. The owner(s) invest money into the business
When a company borrows money, it results in an increase in assets (usually cash, and eventually whatever it buys with the cash) with an offsetting liability (say, a loan on a new delivery truck). Thus, a company's borrowing generally doesn't affect your ability to calculate net income from the balance sheet.
However, transactions involving equity investments do affect our ability to calculate a company's net income. Equity investments result in an increase in assets with no offsetting liability, and thus result in an increase in equity that did not come from earnings. We have to subtract any investments back out from the change in equity from year to year.
Suppose a company reports the following at year end 2014:
- Assets: $1,000
- Liabilities: $500
- Equity: $500
Now suppose it reports the following at year end 2015, after the owner invests $200 more into the business.
- Assets: $1,200
- Liabilities: $600
- Equity: $600
First, we do the same familiar step -- subtract the beginning period equity of $500 from the ending period equity of $600 to get a $100 increase in equity. To get to net income, we need to subtract the $200 investment by the owner from the $100 increase in equity. The company had a net loss of $100 for the year.
It's entirely possible to calculate net income from assets, liabilities, and equity, and these are the three ways to do it under three different scenarios.
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