What is a financial statement? What does it tell us? Why should we care? These are good questions and they deserve an answer.
Financial Statements are summary accounting reports prepared periodically to inform the owner, creditors, and other interested parties as to the financial condition and operating results of the business. The purpose of financial statements is to communicate the Group’s financial information to its stakeholders, especially shareholders, investors and lenders. Financial Statements uses the summarized data contained in the Trial Balance to prepare the business’s financial reports.
Financial Statements provide relevant financial information in a format that is useful in making important business decisions. Each financial statement tells its own story. Together they serve many purposes. They form a comprehensive financial picture of the company, the results of its operations, its financial condition, and the sources and uses of its money. They also allow comparison of different companies with each other, or to evaluate different year’s performance within the same company. Evaluating past performance helps managers identify successful strategies, eliminate wasteful spending and budget appropriately for the future. It can also help a bank or creditor evaluate the company for a loan or charge account. And the Government will be interested in collecting the appropriate amount of income tax. Armed with this information, business managers will be able to make necessary business decisions in a timely manner.
Financial statements have generally agreed-upon formats. There are three main financial statements:
-Trading and Profit and Loss Account
-Statement of Cash Flows
The Income Statement
At the end of a financial period, all expense and revenue accounts are closed to a summarizing account usually called an Income Statement. This is the financial statement that summarizes revenues and expenses for a specific period of time, usually a month or a year. This statement is also called a Profit and Loss Statement. For this reason, all income statement accounts are considered to be temporary or nominal.
-The Profit and Loss Account reflects a Period of Time – month, quarter and year. It shows financial the activity of a business during that period and indicates any profit or loss earned.
-Revenue - the value of your goods and services which have been delivered to customers
-Expenses - costs incurred in earning these revenues.
-Net Profit - the excess of Revenue over Expenses, on the Profit and Loss Account.
-Net Loss - the excess of Expenses over Revenue, on the Income Statement.
The Balance Sheet
The statement of financial position of a business sums up its economic resources, obligations (debts and other non-current liabilities) and owners’ capital at a particular point of time. It also shows how the economic resources contributed by lenders and shareholders are used in the business.
Balance sheet items are classified as assets, liabilities, or capital, and the amount and nature of these items are shown at a specific date in time.
-Assets – Something the company owns that has value
-Liability – Money the company owes to creditors
-Capital – This is the portion that remains after liabilities are subtracted from assets. Capital includes profit or Loss from the business.
-Drawings – Represent assets taken out by owners of the business
The Balance sheet:
-Reflects a Moment in Time.
It indicates Assets, Liabilities and Equity of business as of a specific date.
-Shows Financial Position of Business as of specific date:
Financial Position – what you have/what you owe/what your stockholders have
“Have” – “Owe” = “Value to Owner”
-Value of Business to Owners.
Assets – Liabilities = Capital
Statement of Cash Flows
The Statement of Cash Flows is the third financial statement. The Cash Flow statement shows the inflows and outflows of Cash over a period of time, usually one year. The time period will coincide with the Income Statement. The accounts are analyzed to determine the Sources (inflows) and Uses (outflows) of cash over a period of time The Statement of Cash Flows removes all accruals, deferrals and other non-cash adjustments,. An Income Statement might show a Profit or a Loss, but that says nothing about how the company’s Management managed the company’s money.
Cash Flow Statement:
-Reflects a Period of Time – Month, Quarter, Year
-Shows cash inflows and outflows during period
-Indicates solvency of company during period