Relationships Between Financial Statements

Quick reference

• 00:03 Hi, this is Ray Sheen.
• 00:05 I'd now like to talk about the relationship between the three primary
• 00:09 financial reports, earning statement, balance sheet, and cashflow statement.
• 00:13 They really work together as a system to give us a complete financial
• 00:16 understanding, and that's what we'll look at now.
• 00:19 The first point of comparison is the time period that's covered by each report.
• 00:23 As I've stated,
• 00:25 timing of a transaction is as important as amount in business finance.
• 00:30 Which transactions are in and
• 00:32 which are out of a report are based upon the transaction date.
• 00:35 More than one company has got in trouble with government and
• 00:38 regulatory agencies for playing games with the timing of transactions.
• 00:43 Manage the timing proactively.
• 00:45 Don't doctor the books after the fact.
• 00:46 The earning statement and
• 00:48 cash flow statement both cover a time period such as a month, quarter, or year.
• 00:54 This is in contrast with the balance sheet.
• 00:56 That is for a specific date, or instant in time.
• 00:59 Proactively managing the date of a transaction is the best way to manage
• 01:03 the values in your financial reports.
• 01:05 This is one of the reasons that as we near the end of the year,
• 01:08 we're often told don't spend anymore money this year.
• 01:12 The goal is to move costs out of the financial reports that are being prepared
• 01:16 and doing it in a manner that is consistent with accounting standards and
• 01:20 regulations.
• 01:21 Let's look at this timing pictorially.
• 01:24 We start the fiscal year with a balance sheet that shows the company's value
• 01:28 at that point in time.
• 01:30 We finish the fiscal year with another balance sheet
• 01:32 that shows the company's value at the end of the year.
• 01:35 To explain how things change,
• 01:37 we can study what happened on the earnings statement and cash flow statement.
• 01:41 These two financial reports Will illuminate what happened during the year
• 01:45 that resulted in the changes we see on the balance sheets.
• 01:49 Let's now look at some of the major financial accounting categories and
• 01:52 how those are treated on each of the three reports.
• 01:55 And just to be clear, I'm discussing this for
• 01:57 the condition where business is using the accrual method of accounting.
• 02:02 I'll start with cash.
• 02:03 The total cash balance is shown on the balance sheet.
• 02:06 The beginning cash balances, all the sources and uses of cash during
• 02:10 the period, and the final cash balance, are shown on the cash flow statement.
• 02:15 The earnings statement does not have any representation of the cash position.
• 02:20 Accounts receivable is next.
• 02:21 The balance sheet shows the current level of receivables.
• 02:25 The cash flows statement shows whether that is up or down over the period.
• 02:29 The earning statement does not show receivables, but
• 02:32 it does show total sales revenue, which is an input into the accounts receivable.
• 02:38 With respect to inventory, the value for
• 02:40 the current amount of inventory is shown in the balance sheet.
• 02:43 The cash flow statement will show what changes have occurred to
• 02:46 the value during that period.
• 02:48 The earnings statement will not show the current value of the inventory.
• 02:52 Instead, it will show the value of the inventory that was sold during the period,
• 02:57 regardless of when that inventory was produced.
• 02:59 Accounts payable is similar to accounts receivable.
• 03:02 The current level is shown the balance sheet, and
• 03:05 the changes that occurred are shown on the cash flow statement.
• 03:08 The earnings statement will include the cost of goods sold and services purchased
• 03:12 from suppliers, but it does not indicate whether the bill has been paid yet.
• 03:17 I'll combine fixed or capital assets and depreciation since they are so
• 03:20 tightly coupled.
• 03:22 The balance sheet shows the value of the asset when it was acquired, and
• 03:25 the amount of depreciation charges that have been recorded for each asset.
• 03:29 The earnings statement will show just the depreciation charge for that period.
• 03:34 In other words, the value of the life of the asset that was used up during that
• 03:37 time, and the cash flow statement will show the value of the asset in
• 03:42 the investing activities at the time the asset is purchased.
• 03:45 Therefore, it must add back in the depreciation charge in the ensuing periods
• 03:49 so as not to double count the cost of the asset.
• 03:53 Next is debt, both long and short term.
• 03:56 The total balance of outstanding debt is shown on the balance sheet.
• 04:00 The increase in debt, or
• 04:01 repayment of debt is shown in the cash flow statement as a financing activity.
• 04:05 The earnings statement does not directly show debt,
• 04:08 although it does show the interest payment on the debt.
• 04:11 Our final item is the net income.
• 04:13 This is the calculation that the earnings statement is structured to provide, and
• 04:17 the net income is the starting point for
• 04:18 the operating activities on the cash flow statement.
• 04:21 However, it does not show up on the balance sheet,
• 04:24 although a portion of the net income that is reinvested in the business will be
• 04:28 recorded in the retained earnings portion of equity on the balance sheet.
• 04:32 I'll be mentioning these financial accounts frequently throughout the rest
• 04:37 of this course, so it's very helpful that we understand how they interrelate on
• 04:41 these financial reports.

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