To determine the financial health of any organization, it is vital to take a look at the financial statements. They are critical documents that provide an outlook of the financial information of the organization. While this information can be complex for the layman, the management must learn how to read these statements.
What Are the Four Financial Statements in Accounting?
Typically, all organizations will produce four basic financial statements. These financial statements are:
- The income statement
- The balance sheet
- The cash flow statement
- The statement of shareholder’s equity
The elements of these basic financial statements must be understood along with their relations to each other. Doing so will enable the management to gain a proper understanding of the current financial position of the organization and to help them make the right decisions.
The Income Statement
This statement will contain details about the revenues, expenses, losses and gains of the organization. The revenue refers to the money earned through the normal business operations by the organization. The sale of an asset can result in a capital profit or loss. The net income is calculated by adding the revenues and gains and deducting the expenses and losses from it.
The net income, as mentioned on the income statement, will also be mentioned in the operating activities section of the cash flow statement.
The Balance Sheet
This statement contains details of the assets, the liabilities and the equity of the organization. All details will be presented as they existed on a particular date, typically, the date on which the report was generated. The assets mentioned on balance sheets will be categorized into fixed assets or current assets. Current assets have the highest liquidity, allowing them to be converted to cash easily. Fixed assets are meant to be long term.
Liabilities are categorized similarly. Current liabilities are the monies that must be paid in less than a year. Long-term liabilities have a repayment date of over a year. The shareholders’ equity refers to the total equity of the organization.
The balance sheet is structured in a way that allows the assets to be equal to the liabilities and the equity. This is also known as the accounting equation.
The Cash Flow Statement
This statement shows the total amount of cash that an organization has at the time of reporting. All elements affecting the cash balance will be mentioned within the statement. The operating activities will be the first section of this statement and it displays the operational cash inflow and outflow. This section also contains the net income among other details.
It is followed by the investing activities section which details the monies spent and received on the capital investments. The section on financing activities follows this and it contains details of the cash inflows and outflows as related to the financial securities of the organization.
The Statement of Shareholders’ Equity
The changes that occurred in the equity account of the shareholders are shown in this statement. The actual format of the statement can vary among organizations. It states details such as the beginning balance and ending balance for common and preferred stocks as well as retained earnings.
Of the four primary financial statements, this statement has the least importance in the daily operations of an organization.
The Relationship between the Financial Statements
All of the four financial statements are linked to on another. The management will use the income statement for assessing the use of assets as well as liabilities during the reporting period. The cash flow statement shows the inflows and outflows of cash. This enables the management to learn about the total amount of cash on hand. This will be mentioned in the balance sheet as well. In other words, the main financial statements, when taken together, will provide a comprehensive look and understanding of the financial condition of an organization.
The financial statements will be analyzed by creditors and stockholders for the calculation of various financial ratios. In turn, the ratios and data are used for determining the strengths and the weaknesses of the organization. This reveals whether the organization is worth investing in or is a good credit risk. As for the management, these statements are used to make essential decisions on the running of the organization.
Knowing what the four financial statements are is not enough. It is vital that their elements are understood by the management. Their importance in the organization’s finances cannot and should not be overlooked.
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