What Order Are Financial Statements Prepared?

Financial statements serve as fundamental tools for understanding a business’s financial standing and operational performance. They provide a comprehensive overview, allowing various stakeholders to assess a company’s health. While each statement offers distinct insights, they are interconnected and must be prepared in a specific sequence to ensure accuracy and a logical flow of financial information.

The Income Statement

The income statement is the initial financial document prepared, reflecting a company’s financial performance over a defined period, such as a quarter or a fiscal year. Its primary purpose is to show whether a business generated a profit or incurred a loss. This statement itemizes revenues and expenses, providing a clear picture of operational success. Revenues represent income from typical business activities like selling goods or providing services. Expenses include costs associated with generating those revenues, such as salaries, rent, and utilities.

The net income or net loss figure is the final result on the income statement and a direct input for the subsequent financial statement. Without this result, the next step in the financial statement preparation process cannot be accurately completed. The income statement thus lays the groundwork for understanding how profitable a business has been.

The Statement of Owner’s Equity

Following the income statement, the statement of owner’s equity is prepared, illustrating changes in the owner’s investment in the business over the same accounting period. This statement begins with the owner’s equity balance from the start of the period. It then incorporates the net income or loss directly from the income statement, as profits increase owner’s equity, while losses decrease it. This direct transfer of the net income figure establishes the link between the first two statements.

Beyond net income, the statement also accounts for other transactions affecting equity, such as additional investments by the owner, which increase equity, and withdrawals or dividends paid to the owner, which reduce it. The ending balance of owner’s equity from this statement is then carried forward. This figure is used for the preparation of the next financial statement, ensuring owner’s capital is accurately updated.

The Balance Sheet

The balance sheet is the third financial statement in the preparation sequence, offering a snapshot of a company’s financial position at a specific point in time. It details what a business owns, what it owes, and the owner’s stake. The fundamental accounting equation, Assets = Liabilities + Equity, governs the balance sheet, ensuring a company’s resources are always equal to the claims against them.

The owner’s equity on the balance sheet is the ending balance directly transferred from the statement of owner’s equity. This direct linkage ensures the balance sheet accurately reflects the updated ownership interest after accounting for profits, losses, and owner transactions. Assets represent economic resources expected to provide future benefits, such as cash, accounts receivable, and property. Liabilities are obligations owed to external parties, including accounts payable and loans. The balance sheet’s reliance on the previously calculated equity figure makes its position in the preparation order logical.

The Statement of Cash Flows

The statement of cash flows is the final financial statement prepared, providing a detailed account of the cash generated and used by a company during a specific period. This statement offers a different perspective than the income statement, which focuses on accrual-based revenues and expenses, or the balance sheet, a static snapshot. It categorizes cash movements into three main activities: operating, investing, and financing.

Operating activities relate to cash generated from a company’s normal business operations. Investing activities include cash flows from the purchase or sale of long-term assets or investments. Financing activities involve cash flows from debt, equity, and dividend payments. While it focuses solely on cash, its preparation often draws information from both the income statement, especially the net income figure, and the balance sheet, to track changes in asset and liability accounts. Its reliance on data from the preceding statements makes the statement of cash flows the last to be completed, offering a comprehensive view of a company’s liquidity.