What do the three main financial statements tell users about a business?
Prepare and present the income statement, balance sheet and cash flow statement for a business
The income statement reports profit, the balance sheet reports financial position, and the cash flow statement reports cash movements. Together they present a complete picture of a business.
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What this dot point is asking
You need to prepare each statement, know what it reports, the period or date it relates to, and how the three statements connect.
The income statement
The income statement (statement of financial performance) reports profit earned over a period of time, such as a year. For a trading business it is built in stages:
Cost of goods sold for a period is found from inventory movements:
This statement applies the accrual basis: revenue is recognised when earned and expenses when incurred, regardless of when cash changes hands.
The balance sheet
The balance sheet (statement of financial position) reports what the business owns and owes at a single date. It is a direct presentation of the accounting equation:
Assets and liabilities are classified as current (expected to be realised or settled within twelve months) or non-current. Owner's equity shows opening capital plus net profit less drawings, giving closing capital.
The cash flow statement
The cash flow statement reports cash inflows and outflows over a period, classified into three activities:
- Operating activities: cash from day-to-day trading (receipts from customers, payments to suppliers and for expenses).
- Investing activities: buying and selling non-current assets.
- Financing activities: capital contributions, drawings, and loans raised or repaid.
The net change in cash reconciles the opening and closing cash balances. A business can be profitable yet short of cash, which is why this statement matters alongside the income statement.
How the statements connect
The three statements are not independent. Net profit from the income statement increases owner's equity on the balance sheet. Closing cash on the balance sheet equals the closing cash figure on the cash flow statement. Closing inventory used in COGS appears as a current asset. This interlocking is why a single error in one statement usually shows up in another.
Exam-style practice questions
Practice questions written in the style of SACE Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
2022 SACE Stage 28 marksComplete the income statement for the year ended 30 June, classifying expenses as Selling, Administrative and Financial, then calculate profit or loss. (Revenue and cost of goods sold are given, with expenses including sales staff wages, advertising, shop rent, internet and telephone, depreciation, and interest.)Show worked answer →
A SACE classified income statement is built in order, with expenses grouped by function.
Revenue. Show Sales and Services revenue, then deduct sales returns to reach net sales. Add net sales and services revenue for total revenue.
Cost of goods sold. Deduct COGS (adjusted for any stocktake discrepancy) from net sales to get gross profit. Service revenue is not part of gross profit.
Expenses by classification:
- Selling: sales staff wages, advertising, shop rent (selling space).
- Administrative: internet and telephone, stationery used, office wages.
- Financial: interest, bad and doubtful debts.
- Profit or loss = gross profit + other revenue - total expenses.
Markers reward correct classification headings, all balance day adjustments applied (for example accrued wages added to wages, prepaid rent removed), and a clearly labelled profit figure. Lost marks usually come from misclassifying an expense or forgetting an adjustment.
2023 SACE Stage 28 marksPrepare the balance sheet for Great Australian Bytes as at 30 June 2023, after balance day adjustments, classifying items into current assets, non-current assets, current liabilities and non-current liabilities, and showing net assets and equity.Show worked answer →
Set the balance sheet out in the SACE classified format and apply each adjustment first.
Current assets: Cash, Debtors control less the bad debt written off, less the Allowance for doubtful debts (10% of adjusted debtors), Inventory at the lower stocktake value, and Prepaid rent for the unexpired months.
Non-current assets: Computer repair equipment and Office furniture each shown at cost less Accumulated depreciation (original balance plus the current year depreciation expense), giving carrying amounts.
Total assets = current + non-current assets.
Current liabilities: Creditors, plus the accrued electricity owing of $1,300.
Non-current liabilities: the Long-term loan.
Net assets = total assets - total liabilities. This must equal Equity = opening Capital + profit (from the income statement) - drawings.
Markers reward correct classification, adjustments flowing through (depreciation, doubtful debts, accruals, prepayment) and net assets equalling closing equity.
2024 SACE Stage 27 marksPrepare a statement of cash flows for Baby in Arms for the year ended 30 June 2024, showing net cash flow from operating, investing and financing activities, and the net increase or decrease in cash.Show worked answer →
The statement of cash flows reports actual cash movements under three headings.
Operating activities: cash received from debtors (credit sales adjusted for the change in debtors), less cash paid to creditors (purchases adjusted for the change in creditors), less cash paid for expenses such as advertising and commission (each adjusted for prepayments or accruals). Non-cash items such as depreciation and bad debts are excluded.
Investing activities: cash paid to buy buildings and furniture and fittings (acquisitions paid in cash), shown as outflows.
Financing activities: net loan movement (a repayment is an outflow) and drawings taken in cash (an outflow).
Net increase or decrease in cash = the three subtotals combined. Add the opening cash (or overdraft) to reconcile to the closing bank balance on the balance sheet.
Markers reward the three correct subheadings, accrual-to-cash adjustments, and a closing figure that agrees with the balance sheet.