Introduction
A financial statement may be defined as the formal record that keeps track of all financial activities of a business, an entity or even a person. In some jurisdictions such as in the United Kingdom, the term account is applied in close reference to a financial statement. For any business enterprise, all the significant information appertaining to finance is presented in a well structure manner and in a form that is easy to comprehend. There are basically four different types of financial information that are maintained by every business, accompanied by managerial discussions and analysis. This paper will look into the four financial relevant financial statements, the description of the information contained, how the information is relevant to the managerial team as well as the limitations of using the financial statements.
The balance sheet - also known as a statement of financial position - reports on a firm's liabilities assets as well as ownership equity as at any given point in time. The second financial statement is the income statement. As known as the Profit and Loss statement, the income statement reports on the company's expenses, income and profits over a given period of time. It also provides information on the day to day business operations. These comprise of various expenses as well as sales incurred throughout the processing state.
On the other hand, a Statement of Retained Earnings is used to report as well as provide explanations on a company's retained earnings during the reporting period. Finally, we have the Statement of cash flows which is a document responsible for reporting on the firm's cash flow activities, especially activities related to financing, investing and operating (Wood & Sangster, 2005, pp.72).
For big corporations, these statements are frequently multifaceted and may comprise a widespread set of notes to the financial statements and management analysis and discussion. The notes normally explain each item on the income statement balance sheet, and cash flow statement in more detail. These particular Notes to financial statements are well thought-out as an important component of the financial statements.
The principle objective of all financial statements is to ensure that they provide relevant information concerning the financial position, change in financial position as well evaluating on the performance of an enterprise. This information is relevant and useful to several people who use it to make crucial economic decisions. Therefore all financial statements ought to be reliable, relevant comparable and understandable since all the reported expenses income equity as well as liabilities are all directly linked to the firm's financial position.
Financial statements are anticipated to be comprehensible by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently." (Mortimer, 1980, pp.13) Financial statements may possibly be used by users for diverse purposes. For instance, managers and business owners require financial statements in order to come up with significant business decisions that have an effect on its survival. Thereafter a financial analysis is performed on the particular statements so as to provide the management with a more comprehensive understanding of the figures. Furthermore these statements are a useful tool as part of the management's stockholders' annual report.
The financial statements are useful to employees in the respective companies as they use them in soliciting for collective bargaining agreements, in the event of labour unions or else for talking about issue relating to rankings, promotion or compensation. Potential investors find the financial statements useful especially in the event where they require considering the viability of investing in a company. Financial analyses are regularly used by investors and are organized by professionals known as financial analysts, thus providing them with the foundation for making investment decisions.
In addition, several financial institutions such as lending companies and banks find financial statements useful while deciding on whether to provide a firm with new working capital or to extend debt securities, to finance expansion or any other significant expense. Government entities such as tax authorities require financial statements to establish the propriety and correctness of taxes and other duties affirmed and paid by a company. Lastly, Vendors who provides credit to a business call for financial statements to measure the creditworthiness of the business.
Balance Sheet
For the purpose of financial accounting, a balance sheet provides a summary of all the financial balances of a company, a sole proprietorship or even a business partnership. All the business assets, liabilities as well as ownership equity are outline as of a specific date, mostly at the end of each financial year. A balance sheet is frequently illustrated to be the " snapshot of a company's financial condition" (Wood & Sangster, 2005, pp.9) Of all the above four basic financial statements, the balance sheet can be regarded as the only account that applies only to a single point in time of every business calendar.
For a standard company, the balance sheet has three main parts namely assets, liabilities and ownership equity. The main category of assets is in general listed first and typically in order of liquidity. Assets are then followed by liabilities while the difference between liabilities and assets is referred to as the net worth or capital of the company. According to the accounting equation the net worth is equals to assets minus liabilities. A different way to view the same equation is that assets are equivalent to owners' equity plus liabilities. Taking a closer look at the equation reveals how the assets were financed, either through borrowing or through the use of owner's equity. Balance sheets are as a rule presented with liabilities in one section and assets on the other and the two sections have to balance.
A business functioning exclusively in cash can determine its profits by withdrawing the total bank balance at the end of the financial period, in addition to any cash in hand. Nevertheless, several businesses are not paid right away; they put up up inventories of commodities as well the acquisition of equipments and buildings. In other words every business has assets that cannot be immediately turned into cash at the end of each trading period. Habitually, these businesses also owe money to tax authorities as well as suppliers; moreover the shareholders do not pull out all their initial profits and capital at the ending of each period. Simply, meaning that businesses have liabilities also.
A balance sheet sums up a business or persons assets, equity and liabilities at a precise point in time. Small business and individuals tend to maintain simple balance sheets while larger businesses tend to have multipart balance sheets and which are included in the organization's annual report. Large businesses in addition may prepare balance sheets for section of their businesses.
Income Statement
According to Wood & Sangster, An income statement is a company's financial statement that shows how the revenue is changed into the net income. It exhibit all the revenues realized for a specific period, as well as all "cost and expenses charged against these revenues, including write-offs . . . and taxes." (Wood & Sangster, 2005, pp.444) The oblivious intention of the income statement is to illustrate to the managers and investors on whether the company lost or made money in the course of the period being reported. A contrast to the balance sheet, while the income statement represents a period of time the balance sheet on the other hand represents a single moment in time.
There exist two different methods in the preparation of an income statement. The simpler approach follows the single step income statement, totalling revenues as well as subtracting expenses to come up with the bottom line. With the more complex Multi-Step income statement several steps are involved; starting by subtracting operating expenses from gross profit to achieve at the value of income received from operations. "Adding to income from operations is the difference of other revenues and other expenses. When combined with income from operations, this yields income before taxes . . . which finally produces the net income for the period measured". (Mortimer, 1980, pp.13)
Income statements are usually helpful to creditors and investor in determining their past financial performance, in accessing the potential of creating future cash flows in the course of reporting income and expenses as well as predicting on future business performance. On the other hand, information of an income statement has a number of limitations. For example, items that maybe be relevant but cannot be consistently calculated such as loyalty and brand recognition are not reported. In addition, some numbers are dependent on certain accounting methods while others depend on estimates and judgments.
Cash Flow Statement
For the purpose of accounting, a statement of cash flows - also referred to as the Cash Flow statement - is an account that illustrates how changes in the income and balance sheet affects cash as well as cash equivalents, and narrows down the analysis to financing investing and operating activities. Fundamentally, the cash flow statement is related to the flow of cash in and out of the business. The statement takes into account both the accompanying changes in the balance sheet and the current operating results. As a logical tool, the statement of cash flows is practical in determining the short-term feasibility of a company, predominantly its ability to pay bills.
People and groups concerned about the cash flow statements include; accounting personnel, who require knowing whether the company will be able to meet payroll as well as other immediate expenses, Potential lenders and creditors may want to use cash flow statements with the aim of getting a clear picture on the company's capability to pay. In addition, prospective investors, who want to judge whether the business is fiscally sound as well as potential contractors or employees who require knowing whether the corporation will be able to meet the expense of compensating shareholders of the business.
As reported by Mortimer (1980), cash flow statement is anticipated to present information on a firm's solvency as well as liquidity and its capability to transform cash flows in future conditions, to supply further information for assessing adjustments in liabilities, assets, and equity. In addition, advance the comparability of dissimilar firms' functioning performance by reducing the effects of unlike accounting methods, as well as indicating the timing, the amount, and the likelihood of future cash flows. The cash flow statement has been approved as a benchmark financial statement for the reason that it gets rid of allocations, which might be plagiaristic from different accounting methods (pp.14).
Statement of Retained Earnings
The Statement of Retained Earnings also referred to as Statement of Retained Earnings and Stockholders' Equity among the basic financial statements as per the GAAP principles. It gives details on the changes that are experienced in a company's retained earnings during the reporting period time. It breaks down adjustments affecting the account, for instance losses and profits gained from operations, items charged or credited to retained earnings in addition to dividends paid.
Even though financial statements supply information practical to decision-makers, there is much pertinent information that they omit. Information appertaining to "Factors of market demand, technological developments, union activity, price of raw materials, human capital, tariffs, government regulation, subsidies, competitor actions, wars, acts of nature" (Wood & Sangster, 2005, pp.514) tends to have remarkable consequence on a company's prospects. A significant supposition in the use of financial statements is frequently made that the past will envisage the future. For movements that have sustained for several years this will typically be true, at slightest for the near future. Ratio analysis for a lone business or in an industry using analogous accounting methods will be largely the most fruitful way of utilizing the data provided by financial statements.
