Financial Statements

Financial statements are the final product of the accounting process. They provide information on the financial condition of a company. The common financial statements are (1) the balance sheet, (2) the income statement or the profit and loss statement (P& L), and (3) the cash flow statement. Financial statements allow interested parties to compare one organization to another and/ or to compare accounting periods within one organization. For example, an investor may compare the most recent income statements of two corporations in order to find out which one would be a better investment.

The balance sheet, one type of financial statement, provides a summary of what a company owns and what it owes on one particular day. Assets represent everything of value that is owned by a business, such as property, equipment, and accounts receivable. On the other hand, liabilities are the debts that a company owes — for example, to suppliers and banks. If liabilities are subtracted from assets (assets — liabilities), the amount remaining is the owners' share of a business. This is known as owners' or stockholders' equity.

One key to understanding the accounting transactions of a business is to understand the relationship of its assets, liabilities, and owners' equity. This is often represented by the fundamental accounting equation: assets equal liabilities plus owners' equity.

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ASSETS = LIABILITIES + OWNERS' EQUITY

These three factors are expressed in monetary terms and therefore are limited to items that can be given a monetary value. The accounting equation always remains in balance; on other words, one side must equal the other.

The balance sheet expands the accounting equation by providing more information about the assets, liabilities, and owners' equity of a company at a specific time (for example, on December 31, 2005). It is made up of two parts. The first part lists the company assets, and the second part details liabilities and owners' equity. Assets are divided into current and fixed assets. Cash, accounts receivable, and inventories are all current assets. Property, buildings, and equipment make up the fixed assets of a company. The liabilities section of the balance sheet is often divided into current liabilities (such as accounts payable and income taxes payable) and long-term liabilities (such as bonds and long-term notes).

The balance sheet provides a financial picture of a company on a particular date, and for this reason it is useful in two important areas. Internally, the balance sheet provides managers with financial information for company decision-making. Externally, it gives potential investors data for evaluating the company's financial position.

An income statement is another example of a financial statement. It communicates financial information about a company over a period of time. A standardized format is used to present the financial information. This allows interested parties to compare one income statement to another in order to make informed financial decisions. But there is still a great deal of risk involved in financial decision making because the information reflected in an income statement is subject to a variety of interpretations.

The third type of financial statements is called cashflow. It is a quick measure of the money coming into and going out of a company during a given period of time. It givens a clear idea of a company's true earnings because it excludes accounting tools, such as depreciation, that allow a company to reduce the amount of profits reported on its books in order to pay less taxes. Cash flow factors out all of the accounting tricks and looks at what a company really earned.