Understanding how financial statements connect isn’t just impactful, it’s essential! These statements work together to paint a complete picture of your company’s financial health.
The Three Musketeers of Finance:
Most commonly, the term “financial statements” refers to these three key players:
- Profit and Loss (P&L) Statement: Tracks your income (revenue) against expenses, revealing profitability at various levels.
- Balance Sheet: Shows your company’s net worth at a specific point in time, categorized as Assets, Liabilities, and Owner’s Equity.
- Statement of Cash Flows (SCF): Tracks the movement of your cash over a period, showing how cash flows from operating, investing, and financing activities.
The Intertwined Story:
While each statement has its own function, they’re not isolated entities. Here’s the interconnected choreography:
- The P&L sets the stage: The P&L stands alone in generating information, but can be influenced by journal entries affecting the Balance Sheet. Net Income is the star performer, taking a bow on both the Balance Sheet (as Retained Earnings) and the SCF (as Cash from Operating Activities).
- The Balance Sheet joins the act: This statement showcases your company’s net worth, pulling Retained Earnings from the P&L. It also overlaps with the P&L through various journal entries. Furthermore, the Balance Sheet pushes information to the SCF for most accounts (except cash, accumulated depreciation/amortization, and retained earnings).
- The SCF ties it all together: This statement tracks your cash flow, but doesn’t offer entirely new information. It gathers details from both the P&L (Net Income, Depreciation, Amortization) and the Balance Sheet (changes in account balances).
The Grand Finale:
As you can see, the financial statements are like a well-rehearsed play, each with its role but contributing to the overall story. The SCF, in particular, relies heavily on the other two for its information, especially when using the indirect method.