Financial statements
Financial statements are presentations of the financial
position of an entity as well as the results of its transactions. These
statements are intended to provide information about the financial position and
performance of the entity. It is through such statements that users of the
accounts are able to make decisions. Areas covered by financial statements
include income and expenses, assets, liabilities and capital.
Income Statement
This statement summarizes the results of the trading
activities of the business for a given accounting period (Drake & Fabbozi,
2012). It summarizes the totals of income from trading activities as well as
the expenses incurred in the generation of that income. Thus, a person looking
at the income statement would know what goods and services the business sold or
provided to generate revenues. The person will also get to know the types of
costs incurred in normal business operations just as the earnings or business
profit or loss. Below is an example of an income statement.
XXX
Company
Income
Statement
For
the Year Ended December, 31 2012
$
Sales
100
Cost of Goods Sold (62)
Gross Profit
38
Operating and Administrative Expense (16)
Net Profit
22
Other Revenue 30
52
Income Tax (20)
Retained Earnings 32
Internal users of the income statement
For managers, the income statement helps them in gauging
the profitability of the business (Drake & Fabbozi, 2012). They can compare
the income statement of one year with that of previous years to determine
whether the business is improving or not. Comparisons can also be made between
the income statements of other businesses in the same industry to see whether
the business is faring on well. Managers can, therefore, decide to make
corrective decisions depending on the type of information coming from the
income.
Similarly, employees also have an interest in the
performance of the businesses they work for. From the income statement, an
employee is able to decide stay on as an employee if he/she thinks that the
business is doing well. They may also decide to stay on as employees.
Investors and creditors
For investors, they are interested in knowing whether the
business can generate enough money to provide desirable returns (Drake &
Fabbozi, 2012). Potential investors often compare income statements of
different businesses to choose the one that meets their investment criteria. These
comparisons also apply to income statements across industries.
The Balance Sheet
Unlike the income statement, the balance sheet shows the
financial position of an entity at a specific point in time (Drake &
Fabbozi, 2012). It does this by itemizing the things of value that the company
owns or controls while at the same time listing claims of outsiders over the
assets of the business. The items of value that the company owns or controls
are called assets while the claims of outsiders are called liabilities. Shown
below is an example of a balance sheet.
XYZ
Company
Balance
Sheet
As
at 31 December 2012
$ $
Current Assets
Cash at Bank
30,000
Inventory
250,000
Debtors
75,000
Total Current Assets 355,000
Non-Current Assets
Buildings
550,000
Plant and Equipment 250,000
Vehicles 120,000
Total Non-Current Assets
920,000
Total Assets
1275000
Current Liabilities
Credit cards
15,000
Creditors
110,000
Tax Payable
25,000
Total Current Liabilities 150,000
Non-Current Liabilities
Long-term loans
700,000
Total Liabilities 850,000
Owners Equity
Capital
100,000
Retained Earnings 250,000
Current Earnings 75,000
Total Owners Equity
425,000
For internal users
With the help of the balance sheet, management of a
business is able to know whether the business can discharge its obligations to
outside claims (Drake & Fabbozi, 2012). It is also from the balance sheet
that management can decide on the appropriate method of financing the growth of
the business. Employees are similarly concerned with the ability of the
business assets to pay off the claims from outsiders.
External users
The balance sheet also helps investors and other
providers of capital to know whether the company is capable of generating
enough value for them. It would be pointless for an investor to put his money
in a company that is unlikely to generate a reasonable level of return on
investment.
Statement of Cash Flow
The statement reflects the uses and sources of cash over
a given period of time (Drake & Fabbozi, 2012). This statement is different
from an income statement in that the latter shows flows of income while the
former shows cash flows. Transactions having no effect on cash do not appear in
a statement of cash flow. For instance, depreciation expense appears in the
income statement but it does not feature in a statement of cash flow. To both
internal and external users, the statement of cash flow helps in four different
ways.
First, users are able to understand the difference
between net income and cash flows. Users of financial are also able to know
whether the business is liquid enough to meet its payment obligations. Users
are also able to assess cash and non-cash operations of the business through
the cash flow statement.
Statement of Retained Earnings
This statement shows the balances of undistributed profits
(Drake & Fabbozi, 2012). A company distributes its profits in many ways
including through the payment of dividends. Internal users of financial
statement such as managers and employees can use this statement to assess the
ability of the company to generate internal finances for expansion. On their
part, investors are able to track the willingness of the company to distribute
its profits and most investors will not invest in a company where all monies
are plowed back into the business.
Reference
Drake, P.P. & Fabbozi, F.J. (2012).Analysis of Financial Statements, Third Edition.
New Jersy: John Wiley & Sons.
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