One of the final steps in the accounting cycle is the preparation of the financial statements. The information from the accounting journal and the general ledger is used to develop the income statement, statement of retained earnings, balance sheet, and statement of cash flows -- in that order. Information from the previous statement is used to develop the next statement.
The income statement is the first financial statement you prepare at the end of the accounting cycle. The information on sales revenue and expenses from the accounting journals and the general ledger are used to prepare the income statement. One item of note is depreciation. The income statement is related to the accounting equation through revenue, which increases owner's equity, and expenses, which decrease owner's equity.
The bottom line of the income statement is net income or profit. Net income is either retained by the firm for growth or paid out as dividends to the firm's owners (investors) depending on the company's dividend policy.
The Statement of Retained Earnings is prepared after the income statement because net profit or loss has to be calculated before the Statement of Retained Earnings can be prepared. The Statement of Retained Earnings shows the distribution of profit between retained earnings and dividends. Retained earnings is the amount of profit retained by the firm for growth with dividends the amount paid out by the firm to investors.
The balance sheet is the financial statement that is prepared to illustrate the firm's financial position at a point in time -- on the last day of the accounting cycle. The entries on the balance sheet come from the general ledger and the format mirrors the accounting equation. Assets, liabilities, and owner's equity on the last day of the accounting cycle are stated on the balance sheet.
The Statement of Cash Flows shows the firm's financial position on a cash basis rather than an accrual basis. The Statement of Cash Flows has to be prepared last as it takes information from all three previous financial statements. Two time periods of comparative balance sheets are examined in order to prepare a statement of cash flows.