8. How the Statements Work Together

Let's talk about all the statements. This is where accounting gets fun. Now, I know what you're thinking, it's been fun already, but this is where it gets even more fun. This is where we put the puzzle pieces together. So accounting is not super difficult, it's just a puzzle, right? You just have to figure out the puzzle pieces and how to put them together. So what kind of statements have we talked about so far? We've talked about income statement, we've talked about balance sheet, we talked about statement of retained earnings, let's call that RE. What else? We talked about cash flows.

So we talked about these four different kinds of statements. Now, the real question is, how do all of these go together? We know that they all can be prepared for a single business, and so we're trying to figure out, how do all of these things work together?

Well, it's actually kind of awesome. So let's start with the income statement. So the income statement is revenues minus expenses equals net income. Okay? So that's the income statement. And let's not put a number. Let's just call it income statement.

Now, is there another statement that takes net income as one of its arguments? So is there a statement where we have to have net income to figure out that statement? Well, if you'll recall, the statement of retained earnings is, so let's put retained earnings. Retained earnings is beginning retained earnings plus, bingo, plus net income minus dividends equals ending retained earnings, right? So if we started at the income statement, we ended up with net income, well, we can walk this guy right down here and help us figure out retained earnings. So far we've got two of the statements pretty well knocked out.

So same question, is there a place where we put retained earnings? Let's say that we've got income knocked out, and we've got retained earnings knocked out. So is there a place where we put ending retained earnings? Well, if you'll remember the balance sheet, the balance sheet is just the accounting equation, equals liabilities plus owner's equity. And what is owner's equity? Well, owner's equity is stock or capital and retained earnings. So look, we're working our way down here.

So now we've got step three, right? So we've started up at the income statement, and we said, "Okay, let's take revenues minus expenses and find out what our net income for the year is." We take this guy, plug it into the retained earnings equation and say, "Well, beginning retained earnings plus our earnings minus what we didn't retain is our ending retained earnings." That makes enough sense. And we know that retained earnings is a portion of the balance sheet. So this is the accounting equation, but if we look at a more proper balance sheet, it's gonna look something like this: liability and equity here at the top, you're gonna have liabilities, a bunch of them; equity, you're gonna have stock, and then you're gonna have retained earnings right down here.

And so we know that retained earnings goes onto the balance sheet. So bingo, knocked off another one, which leaves us with poor, lonely cash flows guy. Where do we fit him? Okay, so a balance sheet is, let's say balance sheet ended December 31. So at the end of December 31, we're gonna have a bunch of assets, and one of these assets right here is gonna be cash, let's just say $1,000. So one of these assets is cash of $1,000. Well, cash is a good word if we're looking for statement of cash flows, right? So how does this tie in?

So if you'll remember, the statement of cash flows says, "I've got operating," let's put a title on it. So cash flows says, "I've got operating activities," and a bunch of those, "I've got investing activities," and a bunch of those, "and I've got financing activities," and some of those. And that gives us the change in cash for the year. So the change in cash for the year is some amount. And do you remember the change in cash plus the beginning balance of cash?

Well, if we have the beginning balance plus the change over the year, that should give us the ending balance. And I should put that where it belongs. That should give us the ending balance, which should tie back to your balance sheet.

So balance sheet ended December 31, has a cash value of $1,000, and the statement of cash flows has an ending balance here of $1,000. So let's take a look at this again. Now we've been able to knock off cash flows. Let's zoom back in here.

We started with the question, how do the four of these statements tie together? And I told you, accounting is not hard. Accounting is a puzzle. And then we worked our way through that puzzle by saying, "Well, where should these pieces go?"

Now, let's say you didn't remember where to start. You started at the balance sheet. Well, you're gonna need retained earnings to finish the balance sheet. So then you know, well, I gotta figure out what retained earnings is. And you remember the retained earnings equation, and you look and you see, well, shoot, there's net income. I gotta figure out what net income is. And then you get back up here, and you say, "Well, I know the net income equation is revenues minus expenses." Okay, well, this one has no dependencies at all. So I'll start here. I'll take revenues minus expenses, gives me net income. From there, this piece of the puzzle can go right here, give me retained earnings.

Retained earnings, this piece of the puzzle, can go down here, and I can prepare my balance sheet. Then when I have my balance sheet, I have my ending cash balance, and that should tie out to my ending cash balance on my statement of cash flows.

And so you can see that all of this works together. All these statements work together in a pretty logical and consistent way. And so even if you don't remember where to start, if you get stuck, just say, "Okay, well, I don't know what this is. Gotta work my way backwards. Well, shoot, I don't know what this is. Gotta work my way backwards." And eventually, you'll be able to just put all the pieces of the puzzle together yourself.