Financial statements show how well a company has performed over the year and the level of profit achieved. Investors and regulators may make decisions about a small business based on the information provided by financial statements. Financial statements must be prepared in sequence because the information in one is needed for the next. The sequence of financial statements is: income statement, statement of retained earnings, balance sheet and statement of cash flows.
The purpose of the income statement is to report the company's income and revenue for the year, including net income. Net income is revenue less expenses. Some companies use a single-step method while others use a multi-step method when preparing the statement. The multi-step method would be used by companies with a more complex financial situation while the single-step method by small companies with uncomplicated finances.
Statement of Retained Earnings
The statement of retained earnings explains the changes in retained earnings for the company from net income or loss during the year. Retained earnings are income that is retained by the company to be reinvested instead of being paid out as dividends to stockholders. The steps in the process are listing the beginning retained earnings, subtracting or adding net income or loss and then subtracting any dividends paid out. The result is the retained earnings statement for the company.
A balance sheet summarizes and lists the organization's assets, liabilities and shareholder equity at a particular point in time. It is a snapshot of a company's overall financial situation. The formula for a balance sheet is: liabilities plus equity equals assets. The balance sheet lists a total of all assets, including cash, accounts receivable, inventory and fixed assets. Liabilities such as bank notes and accounts payable are listed, along with the owner's capital invested. The last line of the balance sheet gives the total amount of liabilities and equities, which must be equal to the total assets.
Statement of Cash Flows
The statement of cash flows identifies changes in cash flow generated from operating, investing and financing activities. These three activities, along with any noncash investing and financing activities, make up the statement of cash flows. The statement of cash flows is used to measure a company's financial stability and its ability to pay its creditors.
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