Financial statements is a more common term used to refer to statements produced at the end of the accounting periods, such as the income statement, balance sheet, cash flow statement and the statement of owner’s equity. These four financial statements are sometimes known as the final accounts, which the business prepares.
The income statement also known as the trading and profit and loss account is a financial statement, which helps to calculate the gross profit and the net profit of the company for a particular year. Most of the businesses prepare the income statement because they compare revenues with expenses and check the performance. If the revenue exceeds the expenses, the business has earned a profit and vice versa. The information contained in the income statement is not only, but also useful for the internal users of the business such as the managers and owners but however it is also useful for the external users such as government, investors and creditors’.
For internal users, income statement helps to check the performance and profitability of the business. Owners invest their money merely to earn profits and thus it is necessary for them to check the amount of money they have earned in an accounting period. Similarly, manager’s status is directly linked with the profitability of the business. If the organization has able to achieve higher profits, manager’s salary and status often increases. Moreover, income statements also help to check the revenues and expenses of the business and thus managers can decrease their unnecessary expenses to earn more profits. In the same way, making of income statements is also useful for the external users such as investors, creditors and the government. Investors usually check the income statements of the organization to check the past financial performance of the business and to assess the capability of generating future cash flows. Moreover, creditors also take the help of the income statement to check whether the business has enough revenue to pay its dues on time. Finally, the government needs to check in order to calculate the taxes which the firm has to pay with respect to the profits earned over time.
The balance sheet is another financial statement which shows the assets, liabilities and the capital of the business. This document is prepared at the end of the accounting period, and it helps to check the liquidity position and the current health of the organization. It is based on an accounting model (e.g., assets = capital + liabilities). Internal users, such as managers and owners take the help of the balance sheet to check the liquidity of the business. This document helps managers to manage assets and liabilities so that enough working capital can be made available in an accounting period. By seeing the inventory levels, account payables and account receivables, the managers can change the policies and can reduce the inventory levels. In the same way, external users such as investors and creditors do check the balance sheet to assess risk and collateral issues. The investor would not be reluctant to invest in the business that has high liquidity and gearing ratio. This means the business that has the problem of managing working capital is usually considered a highly solvent business.
The cash flow statement is the third financial statement, which lists the cash flows of a business over a period of time, usually the same period as is covered by the income statement. It helps the business to check its cash inflows and outflows and to see whether the business has cash surplus or shortage. This financial statement is useful in evaluating a company’s ability to pay its bills on time. Cash is considered as the most liquid asset and business that are short of cash usually close down. So this tells the value of preparing the statement of cash…