By Chron Contributor Updated July 19, 2021
Understanding the information contained in your balance sheet, income statement, statement of retained earnings and statement of cash flows is crucial for your business to survive. These four financial statements and how to construct them can help you share information to create an interlocking picture of your business’s financial health. This picture changes daily as each transaction affects one or more of your financial statements. You can update and analyze your financial statements to identify changes in your cash flow and net income.
Statement of Cash Flows
The statement of cash flows takes some of its information from the balance sheet and the income statement. Balance sheet cash transactions are transferred to the statement of cash flows. For example, buying new equipment with cash increases your long-term balance sheet items and appears as a cash outflow on the statement of cash flows. Income statement expenses paid in cash are listed on the statement of cash flows as a cash outflow. When completed, the statement of cash flows reveals how much cash your business took in and how it was used.
Income Statement
The income statement shows your sales revenue, operating expenses and net income for a specific time period, according to Corporate Finance Institute. Sales revenue is broken down into cash and credit sales. The amount of your cash sales is included with the cash account on the balance sheet and are listed on the statement of cash flows. The income statement expenses paid with cash and cash payments made to vendors are included on the statement of cash flows. The net income shown on the income statement is the difference between the balance sheet debits and credits.
Statement of Retained Earnings
The statement of retained earnings uses the net income reported on the income statement to show how much profit your business kept, according to Accounting Tools. The ending retained earnings balance from the previous accounting period is used as the beginning balance for the current retained earnings statement. The net income taken from the income statement is added to the retained earnings beginning balance. After you subtract any dividends you paid, the ending balance shows whether your business profit increased or decreased compared to previous accounting periods.
Balance Sheet
The balance sheet is a snapshot of the balance in each account resulting for your cash and accrual transactions. These transactions are reported on your other basic financial reports. The cash sales reported on the income statement are added to the balance sheet cash account. The credit sales are added to your accounts receivables. The balance of the retained earnings is included in the owner’s equity section found on the balance sheet. The balance sheet accounts fluctuate depending on type of business transaction. Present the four financial statements in order when meeting with potential investors.
FAQs
All four accounting financial statements accurately portray the company's overall financial situation. The income statement records all revenues and expenses. The balance sheet provides information about assets and liabilities. The cash flow statement shows how cash moves in and out of the business.
What are the 4 basic financial statements What is the purpose of each? ›
They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders' equity. Balance sheets show what a company owns and what it owes at a fixed point in time. Income statements show how much money a company made and spent over a period of time.
What are the basic financial statements and how are they related to each other? ›
The three main types of financial statements are the balance sheet, the income statement, and the cash flow statement. These three statements together show the assets and liabilities of a business, its revenues, and costs, as well as its cash flows from operating, investing, and financing activities.
How are the three financial statements linked interview questions and answers? ›
Net income which is profit before tax less tax expense is connected on all three financial statements. Net income is located at the bottom of the income statement and directly at the top of the cash flow statement followed by cash from operations. On the balance sheet, net income feeds into retained earnings.
How do the financial statements tie together and explain them? ›
Net income from the bottom of the income statement links to the balance sheet and cash flow statement. On the balance sheet, it feeds into retained earnings and on the cash flow statement, it is the starting point for the cash from operations section.
How do you combine financial statements? ›
7 Steps: Preparing Consolidated Financial Statements
- Step 1: Understand the Purpose and Scope. ...
- Step 2: Identify Reporting Entities. ...
- Step 3: Gather Financial Information. ...
- Step 4: Eliminate Intra-Group Transactions. ...
- Step 5: Adjust for Unrealized Gains or Losses. ...
- Step 6: Combine Financial Statements.
The 4 types of financial statements
- Balance sheets.
- Income statements.
- Cash flow statements.
- Statements of shareholders' equity.
The 4 Steps in the Closing Process
- Close revenue accounts to income summary (income summary is a temporary account)
- Close expense accounts to income summary.
- Close income summary to retained earnings.
- Close dividends (or withdrawals) to retained earnings.
Financial statements can be divided into four categories: balance sheets, income statements, cash flow statements, and equity statements.
In what order are the four primary financial statements prepared? ›
Answer and Explanation:
| Financial statements |
|---|
| 1 | Income statement |
| 2 | Balance sheet |
| 3 | Statement of stockholders' equity |
| 4 | Statement of cash flows |
The purpose of financial statements is to allow businesses to understand their financial standing. This provides a summary of previous financial data which can help businesses to make informed decisions. This data can also inform other individuals or companies which may potentially have a state in the business.
What are the basic financial statements include all of the following? ›
Correct answer : Option (e) Statement of Cash Flows is the correct answer because the basic financial statements include Income Statement, Statement of Retained Earnings, Balance Sheet, and Statement of Cash Flows, but does not include the Statement of Changes in Assets.
Which one of the four financial statements is most important? ›
Typically considered the most important of the financial statements, an income statement shows how much money a company made and spent over a specific period of time.
What are the main three financial statements briefly describe each of their roles? ›
The income statement illustrates the profitability of a company under accrual accounting rules. The balance sheet shows a company's assets, liabilities, and shareholders' equity at a particular point in time. The cash flow statement shows cash movements from operating, investing, and financing activities.
How do the three financial statements fit together in Quizlet? ›
How are the three financial statements linked? The Income Statement is linked to the Balance Sheet and Statement of Cash Flows through Net Income. Net Income flows to the Balance Sheet through the Retained Earnings account within Shareholders' Equity.
What is the relationship between all of the financial statements? ›
The net income (or loss) from the income statement affects retained earnings on the balance sheet. Depreciation from the income statement reduces the value of assets on the balance sheet. Expenses that are accrued but not paid (like wages payable or interest payable) show up as liabilities on the balance sheet.
What is the interrelationship among the four financial statements? ›
The income statement, statement of owner's equity, balance sheet, and statement of cash flows are all interrelated. The income statement for a period shows how assets and liabilities were used, and relates to the statement of owner's equity. The statement of owner's equity relates to the balance sheet.
How do you connect the financial statements? ›
To connect the financial statements, you need to start with the income statement and adjust for any non-cash items. Then, make changes to the balance sheet and cash flow statement to reflect the adjustments made in the income statement.
Why are the four financial statements vital for the decision-making process? ›
Key Takeaways. Financial statements provide a snapshot of a corporation's financial health, giving insight into its performance, operations, and cash flow. Financial statements are essential since they provide information about a company's revenue, expenses, profitability, and debt.
