Financial statements: analysis and interpretation

¶ … 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 Owners' Equity

The statement of owner's or shareholders' equity is intended to demonstrate the components of change in equity from the end of one fiscal year to the next. Starting with the amount of equity shown at the end of the previous fiscal year, net income is added and then cash dividends paid to the owners are subtracted. If owners contributed any additional capitol this amount, such as the sale of new shares, is also added to the equity. Any capitol withdrawn by the owners is shown as a loss and equity is subtracted. Taken together these the additions and subtractions show the changes in owner equity from one fiscal year to the next.

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.