Question

Question:Lila Corentine is an aspiring entrepreneur and your friend. She is having difficulty understanding the purposes of financial statements and how they fit together across time.

Required

Write a one-page memorandum to Corentine explaining the purposes of the four financial statements and how they are linked across time.

Short answer

Answer

Step-by-step solution

Financial statements and their purpose

Financial statements are the final books of accounts that represent the financial position at a particular point in time. Financial statements include – profit and loss account, retained earnings statement, balance sheet, and cash flow statement.

The objective of these four statements is to provide the right information for making different decisions for different types of users. The financial information is divided into our groups pertaining to the operating performance, income distribution, ownership status, and direction and degree of cash low.

Linkage of financial statements

Each financial statement is linked together. The profit and loss account evaluates the profit earned by the business by listing all incomes and gains on one side and all expenses on the other side.

From the profit or loss calculated in P&L account, the retained earnings statement is prepared that shows the amount of income distributed and retained by the business.

After retained earnings statement Balance sheet is prepared. In the balance sheet, the ‘Retained earnings’ balance works as a balancing figure to match the liabilities with all assets.

Cash flow statement is primarily dependent on the balance sheet and profit and loss account and takes all the figures from these two statements to get the flow of cash during a period.