In What Order Should Financial Statements Be Prepared?

Financial statements are fundamental documents that provide a comprehensive overview of a company’s financial activities and health. These statements serve as essential tools for various stakeholders, including investors, creditors, and management, offering insights into a company’s performance, financial position, and cash flows. The preparation of these financial reports follows a specific, logical sequence to ensure accuracy and consistency.

Understanding the Core Financial Statements

The four primary financial statements each offer a distinct perspective on a company’s financial status.

The Income Statement, also known as the Profit and Loss (P&L) Statement, summarizes revenues, expenses, gains, and losses over a specific period, ultimately showing a company’s net income or loss. It reflects the operational results and profitability of the business.

The Statement of Retained Earnings details the changes in a company’s retained earnings over an accounting period. Retained earnings represent the portion of net income that a company has kept for reinvestment rather than distributing as dividends to shareholders.

The Balance Sheet, or Statement of Financial Position, presents a snapshot of a company’s assets, liabilities, and equity at a specific point in time. It adheres to the fundamental accounting equation: Assets equal Liabilities plus Equity, providing a comprehensive view of what a company owns, what it owes, and the owners’ stake.

Finally, the Statement of Cash Flows illustrates how cash is generated and used by a company across its operating, investing, and financing activities over a period. This statement is particularly important because it reveals the actual cash movements, offering a different perspective than accrual-based net income.

The Required Preparation Order

Financial statements are prepared in a specific order because the output from one statement serves as an input for the next.

The Income Statement is the first to be prepared. This is because it calculates the net income or loss for the period, a figure that is necessary for subsequent statements.

Following the Income Statement, the Statement of Retained Earnings is prepared. This statement directly uses the net income or loss figure derived from the Income Statement. It updates the retained earnings balance by adding net income and subtracting any dividends paid during the period.

The Balance Sheet comes next in the sequence. The ending balance of retained earnings, calculated on the Statement of Retained Earnings, is transferred to the equity section of the Balance Sheet. This ensures that the Balance Sheet accurately reflects the updated equity position of the company.

The Statement of Cash Flows is typically the last financial statement to be prepared. This statement relies on information from both the Income Statement and the Balance Sheet to determine the inflows and outflows of cash. It provides a comprehensive view of cash movements across different business activities.

Information Flow Between Statements

The interconnectedness of financial statements ensures a logical and accurate representation of a company’s financial story. This crucial link ensures that the profits or losses generated during the period are accounted for in the company’s equity. This updated retained earnings figure becomes a component of the total equity on the Balance Sheet, maintaining the accounting equation’s balance. This transfer completes the link between a period’s performance and the cumulative financial position.

For instance, net income from the Income Statement is often the starting point for the operating activities section, especially when using the indirect method. Changes in asset and liability accounts from the Balance Sheet are also used to adjust net income to reflect actual cash flows.

The cash balance reported on the Statement of Cash Flows must reconcile with the cash balance presented on the Balance Sheet, confirming the accuracy of the financial reporting. Any error in one statement can cascade and affect the accuracy of subsequent statements, underscoring the importance of meticulous preparation at each step. This integrated flow ensures that all financial activities are consistently reflected across the various reports.