Which financial statement is prepared first and why? Let’s find out!
Managing finances is a crucial aspect of running any business. Without proper financial statements in place, it’s hard to get an accurate understanding of where your company stands financially. But when it comes to preparing these documents, which one should you tackle first? In this blog post, we’ll explore the different types of financial statements and determine which one should be prepared initially. So sit tight and let’s dive into the world of finance!
What Are Financial Statements?
Financial statements are documents that provide a comprehensive overview of a company’s financial health. They help business owners and stakeholders understand the current state, performance, and growth potential of their organization.
Government agencies, accountants, firms, and others often audit financial statements to ensure accuracy and for tax, financing, or investing purposes. A for-profit entity’s primary financial statements include its balance sheet, income statement, cash flow statement, and equity statement. A nonprofit entity’s financial statements are similar but different.
What Are the Types of Financial Statements?
Financial statements are the backbone of any business, whether big or small. These statements provide a comprehensive overview of a company’s financial health, performance, and position. There are four main types of financial statements that businesses typically prepare:
- Cash Flow
- Balance Sheet
- Income Statement (also known as profit and loss statement)
- Statement of Retained Earnings
Cash Flow
Cash flow is a financial statement that shows the inflow and outflow of cash in an organization. It reflects the amount of money coming into and going out of a company during a particular period. The cash flow statement helps organizations to understand their liquidity position, how they are spending their funds, and how much cash they have on hand. The cash flow statement includes three main sections:
Operating Activities: include transactions related to the primary business operations such as sales revenue, inventory purchases, and payments to suppliers or employees.
Investing Activities: cover transactions related to long-term investments like buying or selling property or equipment.
Financing Activities: reflect transactions related to acquiring funds for businesses through debt or equity.
In summary, Cash Flow statements provide important insights into how well companies manage their finances over time by showing where money is coming from and going towards different aspects of the business.
Balance Sheet
A balance sheet is a financial statement that provides a snapshot of a company’s financial position at a specific point in time. The balance sheet shows the company’s assets, liabilities, and equity.
The assets section includes all tangible and intangible items that have value and can be converted into cash within one year or more.
Liabilities are any debts or obligations that the company owes to others such as loans payable to banks or vendors for purchases made on credit.
Equity represents any residual interest in the assets of an entity after deducting its liabilities. Equity comprises retained earnings (profits made by the business) and other forms like share capital invested by shareholders.
It is an essential document because it helps investors understand how much money has been invested in a business so far versus what has been borrowed; thus helping them make informed decisions about investing their own capital based on this information alone without having access to additional data points like sales figures or revenue projections which would only improve their findings further if available!
Income Statement or Profit and Loss Statement
The income statement, also known as the profit and loss statement, is one of the most important financial statements for any business. It provides a summary of a company’s revenues and expenses over a specific period of time, such as a quarter or a year.
This statement includes all sources of revenue earned by the company during that period, including sales revenue and other operating income. On the expense side, it lists all costs incurred to generate those revenues, such as cost of goods sold (COGS), salaries and wages, rent and utilities.
By subtracting total expenses from total revenues on the income statement, we arrive at net income – which shows how much money was actually earned during that specific period after accounting for all expenses.
Investors use this information to evaluate profitability trends in companies over time. It is also used by lenders when assessing creditworthiness because it helps them understand how easily debt can be repaid based on current earnings levels.
Statement of Retained Earnings
The statement of retained earnings is a financial statement that shows the changes in a company’s retained earnings over a specific period. Retained earnings are the portion of net income that a company keeps for future use, rather than distributing it to shareholders as dividends.
This statement starts with the beginning balance of retained earnings and then adjusts for items such as net income or loss, dividend payments, and any other adjustments. The ending balance is then reported on the balance sheet under stockholders’ equity.
The statement of retained earnings is important because it helps investors understand how a company has used its profits in the past and what plans it may have for them in the future. It also provides insight into whether or not a company is retaining enough profits to sustain growth or pay off debt.
While not always required by law, preparing a Statement of Retained Earnings can be an essential tool when analyzing financial statements to determine if there are trends within your business’ profit distributions.
Which Financial Statement Is Prepared First?
When it comes to financial statements, there are four primary types that every business owner should know. These include the cash flow statement, balance sheet, income statement and statement of retained earnings. But which financial statement is prepared first?
The answer may surprise you – it’s actually the income statement! This document provides a summary of a company’s revenues and expenses during a specific period, such as quarterly or annually.
So why is the income statement prepared before other statements? Well, it can provide valuable insights into a company’s profitability and overall financial health. For example, by analyzing revenue trends over time and comparing them to expenses incurred during that same period, business owners can identify areas where they might need to cut costs or invest more resources.
While all four financial statements are important for understanding a company’s finances holistically, starting with the income statement can help set the stage for deeper analysis down the line.
Why Should the Income Statement Be Prepared Before Other Statements?
The income statement is often prepared before other financial statements because it provides a summary of a company’s revenues and expenses over a specific period. This information can then be used to calculate net income, which is an essential metric for understanding a company’s profitability.
By preparing the income statement first, companies can gain insight into their operating performance and identify areas where they may need to make changes or improvements. For example, if revenue is declining while expenses are increasing, this could signal that the company needs to adjust its pricing strategy or cut costs in certain areas.
Another reason why the income statement should be prepared before other statements is that it provides valuable information for forecasting future earnings. By analyzing trends in revenue and expenses over time, companies can make more accurate predictions about their future financial performance.
The income statement plays a crucial role in helping companies understand their financial health and plan for the future. As such, it should always be one of the first financial statements prepared during accounting periods.
What Is EcomBalance?
EcomBalance is a monthly bookkeeping service specialized for eCommerce companies selling on Amazon, Shopify, Ebay, Etsy, WooCommerce, & other eCommerce channels.
We take monthly bookkeeping off your plate and deliver you your financial statements by the 15th or 20th of each month.
You’ll have your Profit and Loss Statement, Balance Sheet, and Cash Flow Statement ready for analysis each month so you and your business partners can make better business decisions.
Interested in learning more? Schedule a call with our CEO, Nathan Hirsch.
And here’s some free resources:
- Monthly Finance Meeting Agenda
- 9 Steps to Master Your Ecommerce Bookkeeping Checklist
- The Ultimate Guide on Finding an Ecommerce Virtual Bookkeeping Service
- What Is a Profit and Loss Statement?
Conclusion
To sum it up financial statements are essential for any business as they provide information about the company’s financial performance and position. There are four types of financial statements that every organization must prepare – cash flow statement, balance sheet, income statement, and statement of retained earnings. It is crucial to understand which financial statement is prepared first and why. The income statement should always be prepared before other statements because it provides an overview of the company’s revenue and expenses during a specific period. This information is used in preparing other reports such as balance sheets and cash flow statements.
EcomBalance provides businesses with efficient software to manage their finances by streamlining their accounting processes. It helps organizations create accurate financial reports quickly while reducing errors associated with manual methods. Understanding how to prepare different types of financial statements can help businesses make informed decisions based on reliable data. It also ensures compliance with legal requirements related to reporting finances accurately. By using EcomBalance software, companies can achieve greater efficiency in maintaining their accounts while minimizing human errors that could lead to costly mistakes later on.
