Four Basic Financial Statements
Financial statements are the basic means of communicating crucial accounting information about a corporation to interested parties. The four main financial statements include the income statement, balance sheet, statement of cash flows and statement of retained earnings.
Purpose of the Four Financial Statements
The Balance Sheet
The role of the balance sheet is to show the financial point of a business on a specific date such as the end of the year or month. For that reason, another name for the balance sheet is the statement of financial position and it refers to a specific date. The balance sheet provides a picture of the company as the owner of resources or assets that are equal to the claims against those assets. Such claims include the owner’s equity in the company and the company’s liabilities.
The Income Statement
The income statement gives information about the change in financial condition because of the operations of a company. The duration that the income statement covers varies depending on the needs of the stakeholders. According to law and business regulations, public companies should file income statements with the Securities and Exchange Commission every year.
In addition, the income statement recapitulates the expenses incurred and revenues made by the company in an accounting period. The wish of every business is to build revenue with minimal expenses. When revenues surpass expenses during an accounting period, the business gets a net income. On the other hand, if expenses surpass revenues, the business gets a net loss. Getting a net income implies that the business augmented its net assets through its activities. To be precise, the assets created by the business surpass the assets spent in producing the revenues. Most people see the income statement as the most important financial report since it shows whether a company achieved its profitability aim, or in other words, whether it earned an acceptable income.
Statement of Cash Flows
While the income statement centers on a company’s profitability, the statement of cash flows concentrates on its liquidity. Thus, cash flows represent the money that flows in and out of a company. The difference between money that flows in and that which flows out of a corporation creates net cash flows. The cash flow statement comprises three main parts including financing activities, operating activities and investing activities. The statement of cash flow has a direct relationship with the other three financial statements.
Statement of Retained Earnings
A retained earnings statement gives information on variations in the financial state owing to changes in retained earnings in a phase. Retained earnings make up part of a corporation’s net income retained by the company. A company may keep all of its net income for use in increasing operations, or it may pay its stakeholders a part or all of its net income as dividends. For instance, high growth corporations like Google and Sirius Satellite Radio do not give dividends to stockholders.
Rather, they keep profits for expansion, in the future. On the contrary, mature companies like General Electric and Coca-Cola often pay their stockholders a regular dividend. Therefore, investors such as baby boomers who need the comfort of routine dividend compensation may invest in Coca-Cola or General Electric. However, young, and more aggressive growth-oriented investors might invest in Google or Sirius. The duration covered by the retained earnings statement is the same period as the income statement because the retained earnings are dependent on net income.
Financial Statements Usefulness to Internal Users
The financial statements are valuable to internal persons such as managers, employees, internal auditors, and owners in diverse modes. Managers use financial statements to check the growth potentiality of an organization and to get information about strategic decision-making, plan of action as well as proper distribution of resources. Employees use financial statements to check the employer potential to offer their salaries, retirement benefits and other employment benefits.
Owners such as partners, proprietors and shareholders use financial statements to check the safety of their capital invested in an organization as well as return on their capital investment. Owners also use the statements to check the earning ability of the organization. Lastly, financial statements are valuable to auditors as they analyze them during the internal audit program.
Financial Statements Usefulness to External Users
The financial statements are valuable to external users such as investors, creditors, customers, suppliers, and the government. Creditors have an interest in financial statements because they use them to check the repayment capacity as well as the solvency place of an organization. Customers use the statements to check the potential of the organization to supply commodities at a reasonable price on a long-term basis. Governments use financial statements to get necessary information about financial operations, taxation, and business activities of a corporation. Lastly, investors use financial statements to check different business and social activities that take place in an organization.