The four financial statements and their role in business management

Accounting deals with financial transactions between a firm, its employees, customers, suppliers, and owners as well as bankers and various other government agencies. Financial statements provide managers with essential information they need to evaluate the liquidity of an organization. This is the firm's ability to meet current obligations and needs by converting assets into cash, the firm's profitability, and its overall financial health. The balance sheet, income statements, statement of owner's equity, and statement of cash flows provide a foundation on which managers can base decisions. Of the four financial statements only the balance sheet is considered to be a permanent statement, its amounts are carried over from year to year. The income statement, statement of owners' equity, and statement of cash flows are considered temporary because the close out at the end of each year. By interpreting the data provided in these statements, the appropriate information can be communicated to internal decision makers and to interested parties outside the organization ("The Four Financial Statements" NDI).

The Four Financial Statements

The Balance Sheet

The balance sheet is based on the following fundamental accounting model: Assets = Liabilities +Equity. A firm's balance sheet shows its position on a particular date. It is similar to a photograph of the firm's assets together with its liabilities and owner's equity at a specific moment in time. Balance sheets must be prepared at regular intervals because a firm's managers and other internal parties often request this information every day, every week, or at least every month (Kurtz, 2010).

The Statement of Owners' Equity

The statement of owner's or shareholders' equity is designed to show the components of the change in equity from the end of one fiscal year to the next. Beginning with the amount of equity shown at the end of the previous fiscal year, net income is added and cash dividends paid to the owners are subtracted. If owners contributed any additional capitol this amount (such as the sale of new shares) it is added to the equity. On the other hand, if the owners withdrew capitol, equity declines. All the additions and subtractions, taken together, equal the changes in owner equity from one fiscal year to the next (Kurtz, 2010).

The Statement of Cash Flows

Public companies are required to prepare and publish a statement of cash flows. This statement provides investors and creditors with relevant information about a firm's cash receipts and cash payments for its operation, investments, and financing during an accounting period. Statements of cash flows are prepared due to the widespread use of accrual accounting, which recognized revenues and costs when they occur, not when actual cash changes hands. As a result there can be 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 can provide investors and other interested parties with vital information. For example if a firm's income statement reports rising earnings, yet at the same time the statement of cash flows shows that the firm's inventory is rising faster than sales, this could be an indication that demand for the firm's products is softening, which may be a sign of impending financial trouble (Kurtz, 2010).

Conclusion

All of the four financial statements are interactive. Each one affects or is affected by the other in one way or another. Even though they each serve a unique purpose, they all have one common goal, to evaluate the health of a business.