How Financial Statements Work Together for Your Business

How income, retained earnings, and cash flow statements work together

Male business owner sits at computer looking at financial statements

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A company's financial statements are developed from the bookkeeping process of the business firm. As the firm records its financial transactions over an accounting time period, the financial statements begin to emerge.

They are developed through recording the transactions in the accounting journal and the general ledger. Four important financial statements come together from those records and paint a picture of the financial health of a small business: the income statement, the retained earnings statement, the balance sheet, and the cash flow statement. Here's how they work together to help your business.

Key Takeaways

  • Four financial statements in particular work together to paint a picture of financial health: the income statement, the retained earnings statement, the balance sheet, and the cash flow statement.
  • These statements are based on the accounting equation that totals up your liabilities and equity to give you your assets.
  • Understanding these financial statements and how they work together can help you avoid costly breakdowns.

The Accounting Equation

Financial statements are based on the accounting equation, which is stated as:

Assets = Liabilities + Owner's equity

For example, if you as a business owner begin your company with $100,000 of your own money, then spend $15,000 on office computers, furniture, and other supplies, the equation would look like this:

$100,000 = $15,000 + $85,000

The purchase of supplies shifts the purchase price to the liability category while the unspent money remains part of the owner's equity. The total assets remain the same. As more purchases are made and revenue is generated, the numbers change, but the equation always balances.

The Income Statement 

The income statement is the statement of profit and loss and it shows how profitable the firm is. It can be viewed as a sort of report card. A positive net income means your business is making money. A negative net income means your business is losing money. The income statement is developed from the accounting entries for revenue and expenses over the accounting period.

The Statement of Retained Earnings

The statement of retained earnings is developed after the income statement because it uses data from the income statement.

The net income from the income statement is either retained by your business, paid out as dividends, or a combination of both.

The Balance Sheet and the Accounting Equation

Your company's balance sheet shows your company's net worth, separated into assets and liabilities or equity. Balance sheet items are separated into two sides that have to balance since every asset has to be purchased with a liability, like a bank loan, or owners' equity, such as a portion of the retained earnings.


The balance sheet is an indicator of net worth while the income statement is an indicator of profitability.

The Statement of Cash Flows

Does your business have the cash to stay afloat? You will look at the statement of cash flows for this info. It uses data from both the income statement and balance sheet, making it the last financial statement to be developed. This statement tracks how cash is coming into the business and how it is being spent in the areas of day-to-day operations, financing, and investments.

These financial statements are essential elements of a business plan. Some software programs, such as Excel, offer templates. Of course, in building and interpreting these financial statements you should consult an accounting professional.

Frequently Asked Questions (FAQs)

What are financial statements?

Financial statements are documents that show you where all the money in a business is, where it's coming from, and where it's going. This includes the money your business spends, money it receives from customers or clients, and money that is sitting as equity or elsewhere.

In what order are financial statements prepared?

Financial statements are prepared in this order because each one impacts the next: income statement, retained earnings statement, balance sheet, and finally the cash flow statement.

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  1. State of Vermont, Agency of Commerce and Community Development. "Sample Income Statement."

  2. "Statement of Retained Earnings in Detail, Other Reports, and Notes to the Financial Statements."

  3. U.S. Securities and Exchange Commission. "Beginners' Guide to Financial Statement."

  4. University of Minnestoa Extension. "Statement of Cash Flows."

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