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.
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.
What are the four components of financial statements? ›
Financial statements can be divided into four categories: balance sheets, income statements, cash flow statements, and equity statements.
How are the four financial statements linked to each other? ›
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.
How are the financial statements linked? ›
Net Income & Retained Earnings
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 does each financial statement differ from each other? ›
The income statement provides deep insight into the core operating activities that generate earnings for the firm. The balance sheet and cash flow statement, however, focus more on the capital management of the firm in terms of both assets and structure.
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.
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.
Each separate legal entity has its own financial accounting processes and creates its own financial statements. These statements are then comprehensively combined by the parent company to final consolidated reports of the balance sheet, income statement, and cash flow statement.
What is the purpose and relationship of the main financial statements? ›
The general purpose of the financial statements is to provide information about the results of operations, financial position, and cash flows of an organization. This information is used by the readers of financial statements to make decisions regarding the allocation of resources.
What are the 4 primary components of a financial system? ›
The main financial system components include financial institutions, financial services, financial markets, and financial instruments.
What are the four types of financial transactions? ›
There are four main types of financial transactions that occur in a business. These four types of financial transactions are sales, purchases, receipts, and payments.
What is the main purpose of each of the financial statements? ›
"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." Financial statements should be understandable, relevant, reliable and comparable.
Which of the 4 financial statements do you think is the most important and useful in predicting a company's success? ›
The Statement of Cash Flow.
What is the purpose of the income statement? ›
An income statement is a financial statement that shows you the company's income and expenditures. It also shows whether a company is making profit or loss for a given period. The income statement, along with balance sheet and cash flow statement, helps you understand the financial health of your business.
What is the purpose of a balance sheet? ›
The purpose of a balance sheet is to reveal the financial status of an organization, meaning what it owns and owes. Here are its other purposes: Determine the company's ability to pay obligations. The information in a balance sheet provides an understanding of the short-term financial status of an organization.
