Introduction
Accounting has been described as the language of
business. The conduct of business and economic activities involves making
decisions regarding the use of scarce resources (Porter & Norton, 2010). This
can only be possible if decision makers are able to make reasoned choices. Accounting
becomes relevant at that stage by providing decision makers with the necessary
information for making those important decisions. It achieves this through the
various financial statements.
The Income Statement
This statement shows the performance of a business over a
specific period of time. Key information presented in an income statement
includes revenue and expenditure (Porter & Norton, 2010). It is customary
for businesses to prepare their income statements on an annual basis. This is,
however, not a bar for a business to prepare an income statement over some
other short period. Thus, an income statement contains revenue for the period
whether annually or any other shorter period, the expenditure for the period
and profit or loss for the period.
Revenue and expenditure, as used in accounting, do not
have ordinary meaning. The ordinary meaning of expenditure would connote the
mere spending of money on something (Porter & Norton, 2010). Similarly,
revenue is ordinarily understood to mean money received by the business. There
is, however, a need to make a distinction between revenue income and
expenditure on the one hand and capital income and expenditure on the other. Revenue
items relate to the normal operations of the business. For instance, money used
to pay company employees. On its part, capital income or expenditure relates to
the acquisition or disposal of fixed assets. Only revenue items pass through
the income statement.
Balance Sheet
Unlike the income statement, a balance sheet shows the
financial position of a business at a specific point in time. It indicates the
manner in which the business is financed, the level of capital employed as well
the ease with which assets can be turned into cash (Porter & Norton, 2010).
Most businesses prepare a balance sheet at the end of a financial period
although one can prepare one in between. It is through the balance sheet that
one can tell whether a business is solvent or not.
A typical balance sheet has three main sections with each
section further subdivided appropriately (Porter & Norton, 2010). The
assets section represents those things of value over which a business has
control or owns. Plant and buildings are just examples of business assets. An
asset can be fixed or current depending on how long they are expected to stay
in the business. Assets that ordinarily stay in the business for more than one
year are categorized as fixed assets with the others are current assets. The
liabilities section of a balance sheet represents the value of outside claims
on the assets of the business. Liabilities also come in both fixed and short
term categories respectively. For instance, a long term loan is a long term
liability while trade creditors represent short term liabilities. Lastly, the
capital section represents the balance of liabilities subtracted from assets. It
is the part of a balance sheet that represents the interest of the business
owners.
Statement of Cash Flow
This is a summary of cash receipts and payments for a specific
period. The statement usually shows what happened in the given period (Porter
& Norton, 2010). The cash flow statement is different from the income
statement in that notional items such as depreciation do not appear in it. In
essence, the cash flow statement only shows the movement of cash and cash
equivalents.
A cash flow statement comes in handy as a forecasting
tool. From the statement, one can get an estimate of cash requirements for the
next financial period (Porter & Norton, 2010). It is also a good way of
estimating the working capital needs of a business. As such, a business may
decide on the appropriate means to finance the business operations. Even more
important is the utility of cash flow statements as management control tools.
Statement of Retained Earnings
It shows changes in retained earnings over a period of
time. Retained earnings are undistributed profits in the business.
Users of Financial Statements
Financial statements are important to respective users for
a number of reasons. First, they are an important means of communicating
business information (Porter & Norton, 2010). In addition, these statements
show the business in financial terms. Various users, however, rely on these
statements for different reasons.
Internal Users/Managers and Employees
This category of people is the ones directly involved in
the daily operations of the company. Their needs are best served by financial
statements drawn from the perspective of management accounting (Porter &
Norton, 2010). They rely on financial statements primarily for the planning and
control.
External Users: Investors and creditors
Investors already working with the business are
interested in knowing whether the business can continue providing appropriate
returns to justify the continued investment in the business (Porter &
Norton, 2010). This information can only be gleaned from the financial
statements. On their part, potential investors use the statements to evaluate
alternative investment options.
Creditors are also concerned with the financial
statements to evaluate whether the business will be in a position to pay its
debt obligations (Porter & Norton, 2010). For instance, a business whose
income statement indicates massive profits may still fail to discharge its cash
obligations if it turns out that the cash flow statement is not as good as what
the income statement may show.
Reference
Porter, G.A., & Norton, C.L. (2010).Using Financial Accounting Information: The Alternative to Debits and Credits, Seventh Edition.Mason,
OH: South-Western Cengage Learning.
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