The four financial statements and their purposes in business decisions

¶ … Accounting and Financial Statements

The purpose of accounting is to provide managers with the information they need to evaluate the liquidity of an organization. The balance sheet, income statements, statement of owner's equity, and statement of cash flows are financial statements that provide a basis on which managers, investors and creditors can make decisions. Of the four financial statements only the balance sheet, whose amounts are carried over from year to year, is considered to be a permanent statement. The income statement, statement of owners' equity, and statement of cash flows close out at the end of each fiscal year and are considered temporary. David Kurtz (2010) describes each of the four financial statements and their individual purpose.

The Balance Sheet

The balance sheet is based on the following accounting model: assets equal liabilities plus equity. A company's balance sheet reflects its position on a specific date. The picture it paints is of the company's assets together with its liabilities and owner's equity. Balance sheets are usually prepared either daily, weekly, or at least every month and are used by a firm's managers and other internal parties to make decisions pertaining to business activities.

The Income Statement

An income statement is a reflection of a company's so called bottom line. It begins with total sales or revenue generated during a year, quarter, or month, and then deducts all the costs related to producing the revenue. This is accomplished by revealing the flow of resources, revenues, expenses and profits.

This statement is designed to show the performance of an organization over a certain period of time. This information is useful to decision makers when focusing on overall revenues and the costs involved in generating these revenues and provides the basic information needed to calculate the financial ratios mangers during planning and controlling.

The Statement of Cash Flows

A statement of cash flows gives investors and creditors pertinent data about a firm's cash receipts and cash payments for its operation, investments, and financing during an accounting period. All public companies are required to prepare and publish this statement. Statements of cash flows are necessary because of the use of accrual accounting, which recognized revenues and costs when they occur, not when actual cash changes hands. This results in a difference between what is reported as sales, expenses and profits and the amount of cash that actually flows into and out of the business during a period of time.

This statement provides investors, creditors, and other interested parties with critical information; for example if a firm's income statement reports rising earnings, yet at the same time the statement of cash flows reveals that the firm's inventory is rising faster than sales, this could be an indication that demand for the firm's products is softening. This may be an indication of future financial difficulty.

Conclusion

The four financial statements all have one common purpose, to evaluate the economic health of a business. They are interactive in the sense that each one affects or is affected by the other in one way or another. These statements provide indispensable information to assist managers, investors and creditors when making financial judgments.