Financial statements analysis and interpretation

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 Income Statement

The income statement represents the flow of resources: revenues, expenses and profits, which reveal the performance of the organization over a specific period of time. In addition to reporting the firm's profit or loss results the income statement helps decision makers focus on overall revenues and costs involved in generating these revenues. The income statement provides much of the basic data need to calculate the financial ratios mangers use in planning and controlling activities. An income statement begins with total sales or revenue generated during a year, quarter, or month, and then deducts all the costs related to producing the revenue. The final figure on the income statement, net income after taxes, is the so called bottom line (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