Financial statements are used to represent the financial position of a company at a specific point in time and the effects of operations. There are four major financial statements used by public companies: the Balance Sheet, the Income Statement, the Cash Flow Statement, and the Statement of Retained Earnings. A large number of users read companies’ financial statements, trying to utilize the numbers to make informed economic decisions.
Balance Sheet
Also known as the Statement of Financial Position, the Balance Sheet represents the financial position of a company at a specific point in time. The Balance Sheet is a visual representation of the basic accounting equation: assets = liabilities + equity. It lists the accounts of items the company owns, accounts of items that the company owes to suppliers and lenders, and what the company owes to its investors. "Statement of Financial Position helps users of financial statements to assess the financial soundness of an entity in terms of liquidity risk, financial risk, credit risk and business risk." (Accounting-Simplified.com, 2013)
The asset section of the balance sheet contains accounts like Cash, Accounts Receivable, Inventory, Prepaid Rent, Property, and Equipment. The liabilities section includes Accounts Payable, Customer Deposits, Unearned Revenues, Income Taxes Payable, and Salaries and Wages Payable. The equity portion contains Paid-in Capital, Retained Earnings, Accumulated Other Comprehensive Income, and Treasury Stock.
Income Statement
Also known as the Profit and Loss Statement, the Income Statement represents the financial performance of a company over a specific period of time in terms of profit or loss. This statement is a visual representation of the company's revenue and expense accounts. To determine whether the company saw a profit or loss during the period, expenses are deducted from revenues. A positive balance results in profits and a negative balance reports a loss.
Income Statements also include investor-related information, such as earnings per share, or EPS. The EPS is the amount shareholders would receive if all of a company's earnings were distributed at that time according to the amount of stock they owned. "To calculate EPS, you take the total net income and divide it by the number of outstanding shares of the company." (SEC, 2007) Some of the accounts you’ll find on the Income Statement are Sales, Cost of Goods Sold, Gross Profit, Revenues, and Expenses.
Cash Flow Statement
The Cash Flow Statement is a record of the changes in cash and bank balances over the course of a designated period of time. It is broken down into three main categories, Operating Activities, Investing Activities, and Financing Activities. "The information used to construct the cash flow statement comes from the beginning and ending balance sheets for the period and from the income statement for the period." (Quick MBA, 2010) Some accounts recorded on the Cash Flow Statement would be Net Income, Accounts Receivable, Inventory, Accounts Payable, Purchase of Property and Equipment, Proceeds from Line of Credit, and Payments on Long-term Debt.
Statement of Retained Earnings
The Statement of Retained Earnings records adjustments in a company's retained earnings. "Retained earnings refer to any profits made by an organization that it decides to keep for internal use." (Investopedia, 2016) The Statement of Retained Earnings contains the net profit or loss of the period, information about stocks issued or bought back during the period, dividends, any equity gains or losses, any changes in the company's accounting policies, corrections of previous accounting errors, and the closing balance. Some of the account titles are Issued Shares for Cash, Purchase of Treasury Stock, Net Income, Cash Dividends, and Stock Dividends.
Users of Financial Statements
The purpose of financial statements is to help users make better business decisions, based on the current and past financial positions of the company, and those users can be both internal and external. Internal users are within the company producing the financial statements. Some examples of internal users and how they use financial statements are the following:
• Managers and executives use the information contained in financial statements to assess their teams’ and companies’ performance and to make data-driven business decisions.
• Employees can analyze their employers’ financial positions to monitor job security and make informed career decisions.
• Accountants and auditors prepare and analyze financial statements to ensure that companies are following the regulations and laws they must adhere to and to monitor for any discrepancies within the reports.
In addition to the many internal users of financial statements, there is a whole multitude of external users as well. Some examples of external users would be the following:
• Shareholders and prospective investors utilize financial statements to measure the risks involved in investing in companies and monitor their returns on investment.
• Manufacturers and producers rely on financial statements to determine the likelihood of a company paying its debts and to negotiate the terms of lines of credit.
• Consumers can comb through their suppliers’ financial statements to determine whether or not they think they will be able to meet demand for the products sought after.
• Competitors can weigh their own performance against that of other similar companies and use that knowledge to address weaknesses in their own strategies and improve on strengths.
• Individuals can research companies’ financial statements to monitor a variety of things, some may be interested in how a local company’s profits will affect their city, and some may be looking for jobs with prospering firms.
• State and Federal Governments demand financial records to ensure the accuracy of tax documents, and governments themselves produce financial statements to ensure that tax dollars are being allocated wisely and appropriately.