Financial statements depict the operations of a business entity in a certain period. In most cases, financial statements are used to support the strategic development of an individual or a company by providing information about the financial status of the business entity. The parties interested in such statements include business owners, workers, potential investors, financial bodies, government entities, vendors, media, and the general public. For large companies, statements of accounts are very complex and may incorporate a wide set of records and corporate deliberations and analysis. The four fundamental types of financial statements are income statements, balance sheets, cash flow statements, and statements of owner’s equity (Stickney, Weil, and Schipper 7). Therefore, this paper describes these statements and their purpose.
Also known as profit and loss account or earning statement, an income statement depicts the achievement or profitability of organization’s activities within a specific period of time. The heading of this statement shows the name of the business, the statement type, and the duration covered. In principle, the income statement documents all the income realized by the firm during a particular duration and subtracts all its expenses for the same duration to eventually get the net income or the profit for the duration. If in any case the expenses exceed the total income, then a net loss is incurred by the business. An equation for this is: Net Income = Revenue – Expenses (Costales and Szurovy 9).
Revenues are the gains from assets after selling goods and services to consumers. In return of goods and services offered, the company receives assets through cash or payment promises. Expenses show the outflow of assets or an increase in liability. Also referred to as “Cost of good sold”, expenses depict the cost of stocks sold to consumers, or for service organizations, the cost of offering services. Investment and dividend transactions between the stockholders and the firm are not represented in the income statement.
The income statement can be presented in two ways. First, the Single Step statement only finds the total expenses and deducts it from the total revenues. Second, the Multi-Step income statement is more complicated, as it takes some phases to arrive at a conclusion. It first starts from the gross profit, then deducts operating expenses; which gives income from operations. The variation of additional profits and expenses is added to income from operations; this is the income before taxes. When taxes are deducted, the net income is realized for that period
In this light, the function of income statement is to enable administrators and shareholders to establish whether the firm made profit or loss throughout the period presented. It also help shareholders and creditors to analyze the previous business performance of the company, forecast the future financial operations, and analyze the chances of realizing future cash flows through the results generated by income and expenses (Stickney, Weil, and Schipper 20).
The balance sheet is a statement that shows the financial status of the business by providing information on the company’s prolific resources and the money used to pay for those assets at a point in time. In contrast, an income statement shows the financial information within a particular period. Assets, liabilities, and owner’s equity are represented in the balance sheet by the following basic equation: Assets = Liabilities + Equity. The major groups of assets are listed first, and mainly in line with liquidity. Liabilities follow assets in the list, thus enabling easier calculation of net assets. In principle, the net assets must be equal to the variation between assets and liabilities (Weygandt 23).
Assets can be categorized as current or fixed. Current assets are those resources that can be transformed easily into cash. Such assets include accounts receivable, cash, note receivable, inventory, and prepaid assets. Fixed assets are things like property, structures, and equipment. These assets are represented at the original cost, which is less than the market price. Liabilities are part of the company’s assets that are payable to creditors. They can be categorized as short-term (current) or long-term (non-current).
Short-term liabilities include interest owed, wages owed, and accounts payable. Long-term liabilities are things like bonds owed and mortgages owed. Equity represents the money that the stakeholders have presented in line with their rights in the assets of the company (Stickney, Weil, and Schipper 12). In essence, the purpose of a balance sheet is to gauge the capability of the firm to meet its long-term requirements. In most cases, balance sheets for successive periods are compared to ascertain the position of a business. This statement forms the financial structure of the company and the degree of debts owed at a particular point in time (Costales and Szurovy 9).
Costales, S.B. and Geza Szurovy. The Guide to Understanding Financial Statements. 2nd Ed. New York: McGraw-Hill, Inc, 1994. Print.
Stickney, Clyde, Roman Weil, and Katherine Schipper. Financial Accounting: An Introduction to Concepts, Methods and Uses.13th Ed. Ohio: Cengage Learning, 2010. Print.
Weygandt, Jerry. Financial Accounting. 7th Ed. New Jersey: John Wiley & Sons, Inc., 2010. Print.