What are the four most important financial statements? Briefly describe each Much success in today’s business world is tied in with numbers in the form of accounting and financial statements. Being able to understand and properly read these statements is a critical component in truly knowing a business and properly assessing its overall financial performance. Financial reporting is the issuance of written documents in the form of the financial statements by the companies to the shareholders, stakeholders and other interested parties. ‘The objective of these financial statements is to provide information about the reporting entity’s financial performance and position that is useful to the wide range of users for assessing the stewardship of the entity’s management and for making economic decisions. ‘To be ‘useful,’ this information must be ‘represented faithfully, should be complete, prudent and free from material errors at least.’ The purpose of imposing regulations on accounting practices and setting standards is to fulfil the objectives of financial statements.
In the accounting world there are several financial statements but the four main financial statements that are universally understood and prepared for most publically traded companies and many small and medium sized businesses are the income statement, the balance sheet, the statement of cash flows, and the statement of retained earnings (sometimes referred to as shareholders’ equity). A fundamental ability to properly interpret the information these statements contain allows internal and external users to make a wide array of decisions affecting company operations and decisions on whether or not to invest. Users of financial statements look to the income statement to learn and assess a company’s performance over a set period of time, often a month or a year.
This statement depicts the company’s revenues and expenses with the difference reflecting the net income (or loss) resulting from the firm’s business activities. The revenue will be broken down by the category from which it derived with expenses broken down in a similar fashion. Those most interested in a company’s income include shareholders, potential investors, banks (for the purpose of assessing past performance and potential loan risk), creditors, and executives charged with ensuring profitability for the business. The complexity of an income statement will vary based on that of the company from whence it derives and the depth of its business activities (www.accountingcoach.com). In larger corporations an accrual basis of accounting is commonly used where revenues are recorded when the money is actually earned, as opposed to cash being received.
A firm’s revenues, gains, expenses and losses are listed on the income statement. Revenue is money earned from a company’s normal business operations. The expenses on the income statement are the costs associated with earning the revenue. When a company sells one of its assets, it can experience a capital gain or loss. Revenues minus expenses, plus gains minus losses, equal net income or net loss. The dollar amount of net income listed on the income statement is also found on the cash flow statement under the operating activities section.
The balance sheet includes the elements of the accounting equation: assets equal liabilities plus shareholders’ equity. The assets on a balance sheet are classified as either current or fixed assets. Current assets are the most liquid, meaning they easily convert to cash. Fixed assets are long-termed assets. Similar to assets, liabilities are also classified as current or long-term. Current liabilities include money owed to creditors in less than a year. Long-term liabilities are due in one year or later. Shareholders’ equity is the total amount of equity in the firm. The shareholders’ equity section of the balance sheet is explained in further detail on the statement of shareholders’ equity.
Cash Flow Statement
The cash flow statement shows the amount of cash within a company. Items that affect the cash balance are listed on the statement. The first section of the cash flow statement is operating activities, which shows the cash flowing in and out of the company in relation to its business operation. The operating activities section also includes net income and the change in dollars of certain accounts listed on the balance sheet. The next section, investing activities, shows cash the company received and spent on a company’s capital investments. The financing activities section shows the inflows and outflows of cash related to the company’s issued financial securities, which is also listed on the balance sheet and statement of shareholders’ equity.
Statement of Shareholders’ Equity
This statement shows the changes in the shareholders’ equity account. The first line item is the beginning balance for common stock. The amount of newly issued common stock is added to the beginning balance to get the ending balance. The same goes for preferred stocks. Listed next is the beginning balance to retained earnings, which is also listed on the balance sheet. The net income listed on the income statement is added to the beginning retained earnings balance and the amount of dividends paid out to shareholders is subtracted to get the ending balance. The ending balance for common and preferred stock and the ending balance for retained earnings is added together to get the total of the shareholders’ equity.