Companies essentially need to prepare four financial statements. Fundamentally, all these statements comprise of same series of accounting entries, but each statement focuses on a different financial aspect. It is important to understand the relationship between financial statements to know how efficient the operations of a company are.
The income statement of a company tells us the expenses incurred and revenues earned for a defined period. The balance sheet provides information about its financial status pertaining to liabilities, assets and equity of the company as at the completion of that accounting period. The cash flow statement narrates the flow of cash as result of its different activities during that period. Shareholders’ equity statement is a record of the changes in equity account brought by various dealings, responsible for causing changes in rest of the statements.
1. Income Statement and Balance Sheet
Expenses and revenues as contained in the income statement could be connected to certain liability and asset accounts of the balance sheet. Revenue as a result of credit sale is treated as a current asset of the company till payment is received from buyers. Therefore, any such revenue included in the income statement gets recorded as a current asset under the head ‘accounts receivable’ of the balance sheet. There is a similar connection between accrued, non-cash expenses as recorded in the income statement and current liabilities (like accounts payable) as shown in the balance sheet.
2. Income Statement and Cash Flow Statement
Income is accounted for as profit but it may not essentially be in terms of cash. It’s equally applicable that cash flow from operations of the company may not really be the outcome of expenses incurred and revenue earned. Nevertheless, companies may employ figures pertaining to income for calculating actual cash flow from their operational activities. For the purpose of preparing cash flow statements, companies deduct all non-cash proceeds from net income but include all non-cash expenses in the net income shown in the income statement.
3. Balance Sheet and Cash Flow Statement
Balance sheet too is directly connected to cash flow statement. Companies provide information of their entire cash holdings in the cash account of the balance sheet at the completion of the accounting period. However, the cash flow in the balance sheet doesn’t illustrate the real outflow or inflow of cash received against respective transactions for the accounting period. The cash flow statement narrates cash transaction of all business operation like investing, operating and financing. For instance, payment made for acquiring an asset shown in balance sheet is accounted in cash flow statement as cash outflow.
4. Balance Sheet and Shareholders’ Equity Statement
Equity of shareholders is recorded in the equity section of balance sheet that has two more sections. The equity section of balance sheet by itself wouldn’t disclose the status of different accounts but reveals their accrued amounts. The statement of equity of shareholders records amendments in all equity accounts. For instance, cash collected as a result of having extra shares and recorded in balance sheet is accounted by showing increased number of shares while the amount in dollars is shown in the statement of stockholders’ equity.
Analyzing and interpreting the relationship between financial statements is vitally important to know where the company is heading to.