The formulas of financial ratios combine the variables of the financial statements. For example the return of equity formula is calculated in the following manner: net income / shareholders equity. Net income is a variable that is found in the income statement, while shareholders equity is an element from the balance sheet. Two financial statements whose elements interact with each other are the income statement and the statement of retained earnings. The total net income illustrated at the bottom of the income statement is a figure that is added to the initial retained earnings balance. Another relationship of interaction among the elements of the statements is between the statement of retained earnings and the balance sheet. The ending retained earnings balance illustrated at the bottom of statement of retained earnings is the same figure that is shown in the equity section of the balance sheet.
Changes in one financial statement can affect the other financial statement in certain circumstances. The net income total is used in the statement of retained earnings as a variable that is added to the initial retained earnings balance. For example if a company ended with a year-end net losses that figure would set off a chain reaction which affects other financial statements. The losses are moved to the statement of retained earnings where they are subtracted from the initial retained earnings balance. The final retained earnings balance is then transferred to the balance sheet. Not all changes to accounts in one financial statement affect the other. For instance a change in the debt total in the balance sheet does not affect the income statement in any way.
It is important for business professionals to understand the relationship between the four financial statements. The statements together provide a picture of the financial health of an enterprise. A person can make an error analyzing a ...
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