Financial statements are reports of an organization which show financial health of it and help in decision making process for both internal and external users. There are five key financial statements, such as Income Statement, Statement of Retained Earnings, Statement of Stockholders’ Equity, Balance Sheet, and Statement of Cash Flow.
Which financial statement is the most important?
They are all important and should be analyzed and evaluated together with the notes to the financial statements in order to see the full picture of the organization’s situation before making any conclusion or decision about the company. For example, if you see on the Balance Sheet huge borrowings it doesn’t necessary mean that this corporation is not doing good. You should look on the Statement of Cash Flow to see maybe they did some purchase for their major project which might bring them lots of money in some day in the near future.
On the other hand, some decision makers find the parts of a financial statement to be more useful than the whole. Therefore, they find the Income Statement one of the most useful financial statements because income statement elements shown in some detail and in comparison with prior years’ data allow decision makers to better assess future income and cash flows.
When financial statements should be prepared?
Different organizations have their own time frames of financial statement preparation. Commonly Income Statement, Statement of Retained Earnings, and Statement of Cash Flow are prepared monthly, quarterly, or yearly depending on the needs or preferences of the organization. Those statements need to be done over certain period of time. On the other hand, Balance Sheet is prepared at specific point in time (date), such as Dec. 31, 20XX, for example.
Some companies don’t even prepare all four financial statements especially if it is very small business. They don’t want and know how to do them. However, if the firm wants to borrow money or go public then they have to present their financial statements.
Which ties do financial statements have?
Financial statements relationship chart
|
Income Statement |
Statement of Retained Earnings (RE) |
Balance Sheet |
Statement of Cash Flow (CF) |
|||
| CF from operating activities | ||||||
| CF from investing activities | ||||||
| CF from financing activities | ||||||
| Revenue | Net increase (decrease) in cash | |||||
| - | Beginning RE | Cash, beginning of year | ||||
| Expenses | + | Assets (cash) | >>> | Cash, end of year | ||
|
Net income
|
>>> | Net Income | - | |||
| - | Liabilities | |||||
| Dividends | Shareholders equity | |||||
|
Ending RE
|
>>> |
RE
|
How to know which financial statement to prepare first?
The financial statements ties (relationship chart) will determine their order of preparation.
- First financial statement that should be prepared is Income Statement (IS) which contains just data from business operations (Revenues - Expenses) and it will give us the Net Income (NI).
- This NI accountants will use in preparing the second statement, Statement of Retained Earnings.
- By adding NI to beg. RE and subtracting dividends (if any) you will get ending balance of Retain Earning which will be used in calculating the Shareholders Equity section of the Balance Sheet.
- Lastly the Statement of Cash Flow (SCF) will be prepared where the data from IS and BS need to be used. When you do your SCF you just transfer the cash balance to the very bottom of the statement and start work it backwards because you now your final answer already.