Preparing Financial Statements – How These Statements Interconnect
Even though they each contain very distinct information, the three main ﬁnancial statements are completely connected. In fact, you can’t produce a balance sheet without ﬁrst creating a statement of proﬁt and loss, and you can’t prepare a statement of cash ﬂows without having already produced the other two ﬁnancial statements.
The statement of proﬁt and loss contains the bottom-line earnings for the period, whether they’re positive (for proﬁts) or negative (for losses). Those earnings are folded into the owner’s equity, on the balance sheet, at the end of the period. Without that step, the balance sheet could not balance; the equity accounts are not complete until they reﬂect the current period earnings.
No matter which statement you’re working with, all the numbers will be pulled from the general ledger (except the ones the statements calculate). All the statements also speak to the past; they are reporting what happened during the prior period, rather than what’s to come.
The balance sheet is sort of the ﬁnancial statement middleman. It pulls information from the statement of proﬁt and loss and offers information to the statement of cash ﬂows. As you might guess, the statement of cash ﬂows needs to know how much cash the company started the period with, and then works down to the ending cash balance. Sometimes, it needs additional balance sheet information as well, such as the changes in accounts receivable and accounts payable. The statement of cash ﬂows also gives something back to the balance sheet: veriﬁcation. If the ending cash on the balance sheet doesn’t match the ending cash on the statement of cash ﬂows, there’s a mistake somewhere that you need to ﬁx.
The statement of cash ﬂows also pulls information off the statement of proﬁt and loss. Revenues generate cash, even if it’s not immediate (as in the case of credit sales). Costs and expenses eat up cash, though again, the impact may not be immediate.