Financial statements hold the key to determining the financial health of any organization. These critical documents provide an overview of a company’s essential financial information. While this information can be complex for some, it is imperative that management learn how to read and interpret these statements to ensure their company’s continued success.
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
Understanding the elements of these basic financial statements as well as how they relate to each other will enable management to better understand the current financial position of the organization and 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 of the organization. The sale of an asset can result in a capital profit or loss. By adding the revenues and gains and deducting the expenses and losses, the net income can be determined.
- The net income is also referenced 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. These details will be listed as they appear on the date 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 longer 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 STATEMENT OF SHAREHOLDERS’ EQUITY
- The changes that occur 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 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, which 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.
All of the four financial statements are linked to one 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, which shows the inflows and outflows of cash, enables the management to learn about the total amount of cash on hand. This will be mentioned in the balance sheet as well. The main financial statements, when examined as an integrated whole, will provide a comprehensive look and understanding of the financial condition of an organization and can be used by management to make essential decisions on running the organization.
These financial statements are also valuable for external purposes. For example, creditors and stockholders will analyze them to calculate 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.
Knowing what the four financial statements are and how they integrate with each other can greatly enhance an organization’s success.
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