Analysis of the Basic Financial Statements

Financial Statements Description of the Financial Statements Financial statements are fundamental in measuring and gauging the real financial strength of a company. These statements provide measureable data for reports and aid the investor to gain an understanding of a company's imminent prospects and risks (Taparia, 21). The financial activities of any company's business operations and transactions are summarized in three basic financial statements. These are the income statement, balance sheet, and cash flow statements.

The income statement is a financial report, which gives an accounting of the company's income for a certain period of time. Principally, this includes the revenues and expenses that bring about such income. The income statement is also referred to as the profit and loss statement and reveals how an entity has performed by showing the revenues and the expenses and the amount of resultant profit or loss. Items of the balance sheet include revenue, cost of goods, expenses, operating income, tax paid, and the net income as well (Taparia, 21).

The income statement is based on the matching principle which asserts revenues for a certain period of time being analyzed ought to match with expenses in the same period. This practice, accrual accounting, gives rise to the recording of income when a sale takes place and an expense when it is incurred (Taparia, 22). The income statement can be deemed to be the more important and useful financial statement to a possible investor.

This is because, income statements can reveal the operating financial results of an entity, for instance, the sales and the costs and therefore enables the investor to assess the performance of the entity and thereby be able to assess future cash flows (Taparia, 28). Secondly, the balance sheet is also known as the statement of financial position. This financial statement reports the assets of an entity, its liabilities, and the equity levels as well.

It presents information on the financial strength of a company, how incomes are utilized, the cycles of receivables and payables and also equipment (Taparia, 28). The balance sheet gives a presentation of the financial relationships between the assets of the company which are the resources being managed by the company and the liabilities which are the responsibility of the management of the company to creditors and owners or shareholders.

The components of the balance sheet include assets and liabilities, both for the short run and for the long run and equity from the shareholders. Assets include items such as equipment, goodwill, and land while liabilities include items such as loans and payables (Taparia, 28). The cash flow statement of a company provides the users of financial statements with a foundation to evaluate the capacity of the business to generate cash and cash equivalents and the necessities of the company, to make the most of those cash flows (Koen and Oberholster, 17).

According to (Taparia, 32), the cash flow statement highlights and gives a report on account of the company's cash receipts and payment for the accounting period. The cash flow statement consists of three categories, namely financing, operating, and investing. Cash flow from operating activities includes inflow and outflow of cash from the day-to-day operational activities. Cash flow from investing activities includes inflow from sales of assets and returns from investments and outflows from invested funds and long-term purchases.

Lastly, cash flow from financing activities includes inflow and outflow from the issue of stocks or borrowed cash amounts (Taparia, 33). Relationship between the Basic Statements There is a relationship or interconnection between the income statement, balance sheet and the cash flow statement. To start with, the income statement elucidates and clarifies the manner in which the company used its assets and liabilities in a specified period of accounting.

On the other hand, the cash flow statement gives an explanation of the inflows and outflows of cash, and the financial statement discloses the particular amount of cash that the company has at the financial date of reporting. This cash amount that is disclosed is also reported in the balance sheet (Debarshi, 16). Basically, every financial statement mentioned above provides a section of the account of the financial performance and condition of the company. By integrating the three financial statements together, it becomes possible to portray a complete picture.

The income statement is directly related to the balance sheet and cash flow statement.