Question

Describe the purpose of each financial statement and explain the relationship among them

Answer 1

Purpose of each financial statement

Financial statements include balance sheet, income statement and cash flow statement.  The general purpose of the financial statements is to provide information about the results of operations, financial position, and cash flows of an organization. This information is used to make decisions regarding the allocation of resources.

Income statement provides the information regarding ability of a business to generate a profit. It gives information about the volume of sales and various expenses . When reviewed over multiple time periods, the income statement can also be used to analyze trends in the results of company operations.

Balance Sheet inform about the current status or the financial position of the business as on date. this information is used to estimate the liquidity, funding and debt position of an entity.

Cash flow statement show the nature of cash receipts and cash disbursement under various categories.

This entire set of financial statement can be used in various decision making process such as :

Credit decisions, investment decisions, taxation decisions etc. It is also used for calculation of various ratios.

Relationship among them

These three statements are interrelated in several ways:

• The net income figure in the income statement is added to the retained earnings line item in the balance sheet, which alters the amount of equity listed on the balance sheet.
• The net income figure also appears as a line item in the cash flows from operating activities section of the statement of cash flows.
• Changes in various line items in the balance sheet roll forward into the cash flow line items listed on the statement of cash flows.
• The ending cash balance in the balance sheet also appears in the statement of cash flows.
• The purchase, sale, or other disposition of assets appears on both the balance sheet (as an asset reduction) and the income statement (as a gain or loss, if any).

In short, the financial statements are highly interrelated.