Financial Statements Are the Income

¶ … financial statements are the income statement, the balance sheet, the statement of owner's equity and the statement of cash flows. These four statements are used in financial accounting to provide a consistent framework for the recording of a firm's financial information. The purpose of financial accounting is to create a framework by which different firms, either in the same or different industries, can be compared by one another.

This information is used by a wide range of stakeholders, including investors, bankers, managers, creditors and employees. Investors use this information to compare potential investments. Bankers and creditors use this information to help make lending decisions. Employees use this information to better understand their company and their competitors. Managers use this information to determine areas of strength and weakness in their operations, which can allow the managers to make improvements at their own companies or make moves to exploit the weaknesses of their competitors.

The income statement outlines the revenues and expenses of the firm. The income statement includes all accounting flows, so incorporates concepts such as depreciation and other non-cash items. The intent of the income statement is to explain a company's operations over a given period.

The balance sheet shows the firm's assets, liabilities and shareholders' equity. The balance sheet allows stakeholders to understand the degree of leverage that a firm has, and helps provide information about operational efficiency (levels of inventories and receivables, for example). The balance sheet is essential for lenders, because they must know the degree to which the company can handle more debt, and use this analysis as the basis for the lending decision.

The statement of cash flows separates out the cash flows from the non-cash flows on the income statement. This gives the reader a better indication of the cash position of the company, rather than the position with regards to accounting profit. The statement of cash flows separates cash flows into three categories -- operations, investing and financing. This can help analysts to determine where profits and changes in cash position come from -- do they come from successful operations or from other activities.

The statement of changes to owner's equity explains the changes in retained earnings. It illustrates how the company's activities over the period have impacted the value of the owners' stake in the firm.

These statements are all interrelated. The income statement and the statement of cash flows work together to explain not just profits but the sources of positive and negative cash flows. The statement of changes in owner's equity plays a similar role for the balance sheet, acting as a complement to help the investor understand the changes on the balance sheet that specifically impact the firm's owners.