In my previous post, I talked about understanding the financial statements and the 3 main financial statements you need to understand your business namely the:
- Profit and loss statement
- The balance sheet statement
- Statement of cash flow
These 3 financial statements answer the following questions:
- How much profits was generated by the business over a given time – profit and loss statement
- What is the accumulated wealth of the business at any point in time – balance sheet
- How much cash flowed through the business – cash flow statement
When these 3 statements are viewed together they tell the financial health of the business.
To understand how these financial statements relate to each other, you first need to understand the elements of a financial statement.
Elements of financial statements
Financial statements are broken down into categories called elements. These elements are the building blocks of financial statements. There are ten (10) elements of the financial statements namely:
- Assets
- Liabilities
- Equity
- Investments by owners/ contributed capital
- Distributions to owners
- Revenues
- Expenses
- Comprehensive income
- Gains
- Losses
Think of elements like the different departments in a grocery store. Each element stores up information of like items. Every account used in your financial software is classified as one of these elements.
The elements of financial statements are represented in the balance sheet and profit and loss statement as follows:
1. Assets
2. Liabilities
3. Equity
4. Investments by owners/ contributed capital
5. Distributions to owners
6. Revenues
7. Expenses
9. Gains
10. Losses
Element 8: Comprehensive income
Comprehensive income is a measure of income that includes all changes in equity during a period except from those that come from investments by owners and distributions to owners. It is intended to give users of financial statements a more comprehensive view of what has taken place in a business. Comprehensive income is an advanced accounting topic and will not be discussed here.
Balance sheet statement
Every element of the financial statement passes through the balance sheet statement as shown in the diagram below:
In my next post, I will expand on how accounts flow through the financial statements.