Elements of Financial Statements
While we process business events at the transaction level, there may be too many transactions to evaluate when making business decisions. Therefore, at the end of each accounting period, we aggregate transactions into financial statements. Financial statements summarize the impact of economic events on a business's financial condition. Because of the interrelationship between the financial statements, they are prepared in a sequence. The income statement, which is a financial statement that is a summary of the business's revenues and expenses over a period of time, is prepared first. That is followed by the statement of owner's equity, a financial statement that is a summary of changes in the business's equity over a period of time. Then the balance sheet, a financial statement that is a snapshot of the assets, liabilities, and equity of a business at a point in time, is prepared. Finally, the statement of cash flows is prepared as a financial statement that is a summary of inflows and outflows of cash over a period of time, and draws upon the previous three financial statements.As a summary of a business's operations during a period, the income statement reports revenues and total expenses and the resulting net income. This statement aims to adhere to the matching principle, which attempts to match expenses incurred during a period with the revenues earned during that same period. The difference of revenues less expenses is net income if revenues were greater than expenses. If expenses are greater than revenues, then the result is a net loss. Net income is used to determine the changes in owner's equity over a period. The income statement is also referred to as the P&L, or profit-and-loss statement.
Statement of Owner's Equity
Statement of Cash Flows
Interrelationships of 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. This last relationship between the statement of owner's equity and the balance sheet allows the balance sheet to balance. The statement of cash flows then details the company's cash inflow and outflow during the period, and the amount of cash the company has. That amount should match the cash reported on the balance sheet.The four financial statements relate to each other and correlate to provide external users, such as creditors, customers, lenders, and government agencies, an accurate and important financial picture of a business entity. By examining all the financial statements, which reveal both strengths and weaknesses, good investment and credit decisions can be made by external users, such as stockholders, lenders, and others. Managers can also use the financial statements' information for effective financial planning and decision-making.