The company’s financial data is the result of the accounting process in the commercial company. Once the company records financial transactions over an accounting period, financial data begins to appear.
Accounting Equation
Financial data relies on the accounting equation, which is defined as follows:
Assets = Liabilities + Owner’s Equity
For example, if you, as a business owner, start your company with $100,000 of your own money, and then spend $15,000 on desktop computers, furniture, and other supplies, the equation would look like this:
$100,000 = $15,000 + $85,000
The purchase price is transferred to the liabilities category while the unspent money remains part of the owner’s equity. The total assets remain constant. As further purchases are made and revenues are generated, the numbers change, but the equation always remains balanced.
Income Statement
The income statement is the profit and loss statement and shows how profitable the company is. It can be considered a type of report card. Positive net income means your company is making a profit. Negative net income means your company is incurring losses. The income statement is developed from accounting entries for revenues and expenses over the accounting period.
Statement of Retained Earnings
The statement of retained earnings is developed after the income statement because it uses data from the income statement. The net income from the income statement is either retained by your company or paid out as dividends or a combination of both.
Balance Sheet and the Accounting Equation
The balance sheet for your company shows its net worth, and the balance sheet items are divided into two sides that must balance, as every asset must be purchased with a liability, such as a bank loan, or owner’s equity, such as a portion of retained earnings.
Note: The balance sheet is an indicator of net worth while the income statement is an indicator of profitability.
Cash Flow Statement
Do you have enough cash in your business to survive? You will look at the cash flow statement for that information. The cash flow statement uses data from both the income statement and the balance sheet, making it the last financial statement to be developed. This statement tracks how cash enters the business and how it is spent in areas of daily operations, financing, and investing.
These financial statements are essential components of the business plan. Some software programs, like Excel, provide templates. Of course, when building and interpreting these financial statements, you should consult a professional accountant.
FAQs
What are financial statements?
Financial statements are documents that show you where all the money in the business is, where it comes from, and where it goes. This includes the money your company spends, the money it receives from customers or clients, and the money sitting as equity or elsewhere.
In what order are financial statements prepared?
Financial statements are prepared in this order because each one affects the others: income statement, statement of retained earnings, balance sheet, and finally, cash flow statement.
Source: https://www.thebalancemoney.com/the-relationship-between-the-financial-statements-393589
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