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Understanding Financial Statements
Financial statements are formal records of the financial activities of a business, person, or other entity. It provides an overview of a business or person's financial condition in both short and long term. It is a tool used to communicate financial information of an entity to those who wants to make decision and informed judgments about the entity's financial position, results of operation and cash flows.
There are four financial statements Balance Sheet, Income Statement, Statement of Cash Flows and Statement of changes in owner's equity. These four financial statements have unique purpose but they are interrelated.
Income statement is also referred to as Statement of Earnings, or Profit and Loss Statement and Statement of Operations. Income statement indicates a company's profitability during a specified time. It measures all revenue sources and deducts the expenses over a given period of time. There are major components of income statement:
Sales, which represents the gross revenue generated from sales of merchandise or rendering of services.
Cost of goods sold or sometimes called cost of sales are direct cost associated while selling the merchandise or providing the service. Gross Profit sometimes referred to as gross margin, is the difference between sales and cost of goods sold. Operating expenses, these are the selling, general and administrative expenses that are needed to run the business. Net income before taxes is the amount earned by the business before paying taxes. Income taxes are taxes paid by the business to local, state and federal government. Net income after taxes is the earnings of the business. It is computed by deducting the taxes from net income before taxes.
Balance Sheet also referred to as Statement of Financial Position because it summarized the entity's resources, obligations and owners claims as of a given point in time. It is often described as the snapshots of a company's financial condition. Balance sheet has key components:
Assets represent the amount of resources owned by the entity. There are two kinds of assets, current and non current assets. Current assets are cash, stocks, inventories and short term investment that can be converted into cash in one year. Meanwhile non current assets are assets that will not be converted into cash within one year or during the course of business.
Examples of non current assets are value of life insurance, copyrights, long term investments, land, buildings, leasehold improvements, equipment, machinery and vehicles. Liabilities are simply amounts owed to other company. Like assets, liabilities have two kind Current and non current liabilities. Current liabilities are obligations of the business of the business that are due and payable in one year. Non current liabilities are obligations of the business that aren't due for at least one year. Owner's equity which is also called net assets is the total amount invested by the stockholders plus the net income or profit of the business. They key components of owners equity includes common stock, paid in capital and retained earnings.
Statement of Owner's Equity is also referred to as Statement of retained earnings. It is one of the basic financial statements. It explains the changes in companies retained earnings over the reporting period. It break downs changes affecting the accounts, such as profits and losses from operations, dividends paid, and any other items added and subtracted to retained earnings.
Statement of Cash Flows is a financial statement that shows how changes in balance sheet and income statement affect cash and cash equivalent Cash flow statement reflects business liquidity and solvency. It is divided into four categories: Net cash flows from operating the activities, net cash flow from investing activities, net cash flows from financing activities. Operating activities includes receipts for the sale of loans, debt, and equity in trading portfolios. It also includes receipts from sales of goods and services. Interest received from loans and dividends from equity securities. It also includes payments to supplier for goods and services, for salaries of employees and interest on loans.
Investing activities includes purchase of assets such as land, buildings, equipment and marketable securities. It also includes loans made to supplier or customers. Financing activities includes inflow of cash from the investors and the outflows of cash from the shareholders such as payments of dividends and its taxes.
Financial statements are intended to be understandable by readers who have adequate knowledge of business and economic activities. It must be reliable, comparable, and relevant and show profitability. It should provide investor information to help them make a decision if they wished to invest some money into the company.
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