Accounting is the language of business. It is the system of recording, summarizing, and analyzing an economic entity's financial transactions. Effectively communicating this information is the key to the success of every business. Those who rely on financial information include internal users, such as a company's managers, employees, and external users, such as banks, investors, governmental agencies, financial analysts, and labor unions. These users depend upon data supplied by accountants to answer the following types of questions: * Is the company profitable? * Is there enough cash to meet payroll needs? * How much debt does the company have? * How does the company's net income compare to its budget? * What is the balance owed by customers? * Has the company consistently paid cash dividends? * How much income does each division generate? * Should the company invest money to expand?
Accountants must present an organization's financial information in clear, concise reports that help make questions like these easy to answer. The most common accounting reports are called financial statements.
Understanding Financial Statements
The financial statements shown on the next several pages are for a sole proprietorship, which is a business owned by an individual. Corporate financial statements are slightly different. The four basic financial statements are the income statement, statement of owner's equity, balance sheet, and statement of cash flows. The income statement, statement of owner's equity, and statement of cash flows report activity for a specific period of time, usually a month, quarter, or year. The balance sheet reports balances of certain elements at a specific time. All four statements have a three-line heading in the following format:
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The income statement, which is sometimes called the statement of earnings or statement of operations, is prepared first. It lists revenues and expenses and calculates the company's net income or net loss for a period of time. Net income means total revenues are greater than total expenses. Net loss means total expenses are greater than total revenues. The specific items that appear in financial statements are explained later.
Statement of owner's equity
The statement of owner's equity is prepared after the income statement. It shows the beginning and ending owner's equity balances and the items affecting owner's equity during the period. These items include investments, the net income or loss from the income statement, and