Financial statements are one of the primary tools companies use to communicate their financial health and performance to both internal and external stakeholders. For public companies, financial statements must be prepared according to strict accounting standards and published on a regular basis. But preparing accurate and reliable financial statements takes careful planning and execution.

So what exactly is the process that accounting teams follow when putting together the various financial statements? Let's take a deeper look at the standard order of operations and why each step is important.

1. Prepare the Income Statement

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The income statement, also known as the profit and loss (P&L) statement, is typically the first financial document accounting teams work on. This makes sense, as the income statement summarizes a company's revenues, expenses and net profits or losses over a set period of time, like a quarter or fiscal year.

By quantifying revenue generated from core business operations versus operational costs, the income statement reveals how effectively management is running the company on a day-to-day basis. Did revenue increase or decrease compared to prior periods? Were costs well controlled or did expenses inflate significantly? The answers to these questions influence important strategic decisions at the C-suite level.

As the "top line" financial metrics, revenue and net income are also key indicators closely watched by shareholders, analysts and other external stakeholders. Preparing the income statement first allows accounting teams to hit these high level profitability metrics ahead of other statements.

2. Draft the Balance Sheet

Once the income statement shows profitability, accountants move on to creating the balance sheet. As the name suggests, the balance sheet provides a snapshot of what a company "balances" - its assets, liabilities and shareholders' equity on a single date, like the last day of the quarter or fiscal year.

By detailing asset types from cash to property to long-term holdings, the balance sheet paints a picture of resources available to the business. It also quantifies debts, obligations and sources of funding through shareholders' investments that allowed those assets to be acquired. Total assets must always equal the total of liabilities plus equity.

Key balance sheet ratios like the current ratio and debt-to-equity ratio surface valuable insights into liquidity, leverage, and overall financial position. They become critical reference points for modeling future cash flows, growth projections and risk levels.

3. Develop the Statement of Cash Flows

Compared to the other two statements based on accrual accounting, the statement of cash flows stands apart by tracking actual cash inflows and outflows. This bridges the gap between the accrual-based income statement and balance sheet with real-world cash flow realities.

Accounting teams prepare this statement next in the sequence because it reconciles revenue and profit metrics to hard cash generated from core business activities. Was cash converted efficiently from sales? How was cash deployed across investing activities like capital expenditures? This statement is also the connective thread between the opening and closing balance sheets of a fiscal period.

By categorizing cash sources and uses, analysts gain insights into factors impacting short-term liquidity as well as long-term aspects like a company's ability to fund future growth through internally-generated cash flows versus relying on outside capital.

4. Draft Notes to the Financial Statements

No set of financial statements would be complete without accompanying notes.. Detailed notes flesh out assumptions, policies, estimates and other items requiring clarification or explanation that don't have a place within the main numeric statements themselves.

Areas commonly addressed in the notes include changes in accounting methods, contingencies, commitments, significant estimates and risk factors. The notes serve to enhance transparency around numbers reported. They ensure statements are properly understood by describing complex methodologies in plain language.

Accounting teams finalize the notes last but they play a crucial supporting role, complementing the core stats. Well-written explanatory notes reinforce the integrity and accuracy of reported results for both internal managers and external users of financial information alike.

5. Key Financial Statement Takeaways

Preparing financial statements adheres to this logical flow:

Income statement reveals profitability

Balance sheet quantifies resources & obligations

Cash flow statement reconciles cash impact

Notes provide context around assumptions

While technology assists with calculation, a human perspective ensures concise yet comprehensive communication of a business's financial story. Adherence to accounting standards facilitates consistent and accurate external disclosures over time as well.

Together, financial statements empower managers to improve performance and strengthen investor confidence with clear visibility into historical results and future prospects.

6. Frequently Asked Questions

What policies determine which expenses are deducted when?

Strict accounting rules dictate timing of expense recognition based on accrual concepts. Examples include debt issuance costs expensed immediately versus amortized over life.

Are non-cash expenses still deducted from net income?

Yes, non-cash expenses like depreciation are deductible as they represent allocation of asset costs over useful life, not actual cash outflows. This follows accrual basis of accounting.

When are balance sheet items valued - at cost or fair value?

Items are carried at historical cost unless standards require fair value, e..g. certain securities, derivatives & defined benefit pension plan assets/liabilities.

How do extraordinary items affect income statement vs balance sheet?

Extraordinary items are after income tax and disclosed separately on income statement but included in net income. Balance sheet is unaffected.

How do discontinued operations change statement presentation?

Results of discontinued operations appear as single line item below net income on income statement. Assets and liabilities are classified as current on balance sheet.

What accounting policies must be disclosed in notes?

Material policies on revenue recognition, inventory, depreciation, and other significant areas critically impacting financial statement interpretation as outlined in accounting standards.