How The Big 3 Financial Statements Link Together
There are 3 financial statements you should know:
Balance Sheet Statement
The balance sheet shows a financial snapshot of the business at a specific point in time, usually at the beginning and end of an accounting period. It sets out the assets of the business and how they have been funded. It tells you what your business is worth at book value.
The general format of the balance sheet is governed by the accounting equation as follows:
The top part of the balance sheet is the assets of the business, property, machinery, fixtures, inventory, debtors, cash etc. The bottom part of the balance sheet shows how those assets have been funded by liabilities such as supplier credit, bank loans, and by equity. Equity includes capital injected by the owners of the business and retained earnings from the trade of the business.
|Liabilities + Equity
The income statement shows a business’s financial performance over an accounting period. The accounting period can be any length but is usually a month or a year.
The income statement is used to tell whether a business has made a profit or a loss for the period, and follows the general format of Revenue – Expenses = Profit.
It tells you what profit is left for you, the owner of the business.
The income statement may also be referred to as the profit and loss account, the earnings statement, or the income and expenditure statement, they all mean the same thing.
Notice that the movement between the opening and closing retained earnings (highlighted blue) in the balance sheet is 305 – 250 = 55, which is the profit for the period shown by the income statement.
Cash Flow Statement
The Cash Flow Statement shows a business’s cash inflow and cash outflow over an accounting period. The accounting period can be any length but is usually a month or a year. The cash flow statement tells you whether you have the cash to pay your bills.
Cash flows in include receipts from the trade of the business, new loans, and new equity. Cash flows out of the business include payments for expenses of the business, fixed assets, loan repayments etc.
|Cash flow in
|Cash flow out
|Net cash received / (paid)
The net cash received or paid during the accounting period is referred to as the cash flow. In the above example, the cash flow is 40 into the business.
Notice that the movement between the opening and closing balance sheet cash balances (highlighted in green on the balance sheet), is 100 – 60 = 40 increase, which is the same as the cash flow of the business for the period shown in the cash flow statement.
3 Financial Statements Connected
There are 3 financial statements which you need to understand to operate your business effectively, the income statement, balance sheet statement, and the cash flow statement.
The balance sheet statement shows the assets of a business and how they have been funded by liabilities and equity at a particular point in time, usually the beginning and end of the accounting period.
The income statement shows the profit of the business for the period, which is equal to the movement on the retained earnings account between the opening and closing balance sheets.
The cash flow statement shows the net cash in or out of the business for the period, and the cash flow is equal to the movement on the cash balance between the opening and closing balance sheets.
The connections between the 3 financial statements are indicated in the diagram below and discussed further in out links between financial statements in a business plan post.
3 Financial Statements Examples
The 3 financial statements change in presentation and format depending on the business involved, and the purpose of the 3 financial statements. A typical example of each for a quoted business is shown in the annual report for Apple in the links below.
- Annual report for apple balance sheet statement
- Annual report for apple income statement
- Annual report for apple cash flow statement
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.