Financial statements are basically records that indicate a business or organizations financial status. In essence, they quantitatively report on company’s financial health. Financial statements are normally prepared quarterly or annually. In the accounting profession, there are basically four financial statements that have to be prepared and maintained. These are Income statement, balance sheet, cash flow and statements of retained earnings.
Purpose of the financial statements
The income statement reports on the primary yardstick of business performance, net income. While the common term used is profit, accountants normally prefer to use the term net income. It actually shows the revenues the company has managed o earn within a specified time. Additionally, t also shows the expenses and costs incurred by the company to earn the incomes over the same period. However, the bottom line of the statement is the net income which indicates how much the company has either earned or lost. It should however be noted that income statements also report on earnings per share (EPS) which shows how much each shareholder would be entitled to if the company decides to distribute all the net income for the particular period (Nobes,1997). Hence the basic formula for net income is
REVENUES – EXPENSES =NET INCOME
A balance sheet is essentially a detailed report on a company’s liabilities, assets and shareholders equity. Assets are the valuable endowments of a company. They can be raw materials for making final products to be sold or final products that can be sold. They include Plant, equipment, trucks, and inventory. Additionally, it includes intangibles such as trademarks and goodwill. Liabilities refer to the amounts owed to others by the company. They include obligations such as bank loans, money owed to the company suppliers among others. Finally shareholders equity also referred to as net worth or capital refers to the amounts that would be left to the shareholders in the event the company disposed off all of its assets and used the returns to pay their creditors. The formula below summarizes what a balance sheet entails
ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY
Cash Flow Statements
Cash flow statements report on the inflows and outflows of cash within the company. This therefore shows the liquidity position of the company to enable it operate efficiently. It essentially shows the changes that occur over time by using information from the balance sheet and the income statement. It is the cash flow that shows whether the company has generated cash for the company to enhance its operations. The bottom line in this statement is an indication on whether there has been a net decrease or increase of cash in the period in question (McCrary, 2009). Generally, the statement is normally divided into cash from operating, investing and financing activities. The general formula is:
Statement of Retained Earnings
This financial statement reports on the changes to the equity segment of the balance sheet. This includes: retained earnings, other comprehensive income and common and preferred stock. Retained earnings normally appear on the balance sheet and are on most occasions affected by dividends and income. This relationship can best be shown by the equation
There are several users of financial statements and, they can broadly be classified as internal or external users. The internal users are those who are directly linked with the organization. Mainly, they are composed of managers and owners as well as the employees of the company. On the other hand, external users are composed of institutional investors, financial institutions, government, suppliers, investment analysts, labor unions among others.
How Financial Statements Would be Useful to Internal Users, Such as To Managers and Employees.
For the managers and owners of the company, financial statements help them in making the critical decisions required to facilitate the smooth operation of the company. Financial analysis is normally done to provide a very comprehensive view of the general health of the company. Hence, financial information can be used by the management to draft contractual terms with other parties. Variables such as current debt to equity ratio are very critical in coming up with the amount of capital to be raised. In deciding on the right areas to invest, the financial statements of other companies can provide a guide for the management (Bandler, 1994).
For the employees, financial statements are very important in formulating collective bargaining agreements with the management. They are used to discuss on issue of salary hike, rankings and promotions of the employees.
How the financial statements would be useful to external users, such as investors and creditors
External users are those who use the financial statements to assess the company’s financial health. For the investors, financial statements help them in ascertaining the best financial decisions. This extends to the prospective investors as they too can be able to determine if at all the company they want to invest in is viable. For the creditors, financial statements help them to ascertain if the company has the capacity to pay them. By looking at the cash flow of the company and the balance sheet, they can be able to ascertain the liquidity position of the company that will determine how soon they can be paid (Bandler, 1994).
Admittedly, financial statements are very critical in providing financial information to all the stakeholders. The statements are so much related that it helps the shareholders to have a continuous flow of the financial position of the company. Additionally, for the users of financial information, the interlinked nature of the statements helps them to form a clear opinion on the financial position of the company to help them in arriving at the appropriate decisions.
Bandler, J. (1994).How to use financial statements: a guide to understanding the numbers. New
Jersey: McGraw-Hill Professional.
McCrary, S. (2009).Mastering Financial Accounting Essentials: The Critical Nuts and Bolts.
York: John Wiley & Sons.
Nobes, S. (1997). Introduction to financial accounting. New York: Cengage Learning.