February 27, 2013
Financial Statements Financial statements are used to determine the financial welfare and prospective earnings of an organization. These statements are often used by accountants, business owners, investors, and employees. In this paper, one will discuss the four basic financial statements: balance sheet, income statement, statement of retained earnings, and statement of cash flow. One will also describe the purpose of each of the four financial statements, how the financial statements would be useful to internal users such as managers and employees, and how the financial statements would be useful to external users such as investors and creditors.
The purpose of a balance sheet is to report the financial position of a company. It is also used to disclose a company’s assets, liability, and owner’s equity or net worth of an accounting entity at a specific point in time. The balance sheet is divided into two columns. The first column on the left lists the company’s assets (what the company owns), and the second column to the left lists the liabilities and net worth (what is owed to the company). At the bottom of each list is the total of that column. The bottom of the balance should always be in balance. In other words, the total assets are equal to the total liabilities plus the net worth (Marianne Heuy, 2013). An income statement known as statement of Profit and Loss (P&L) shows the revenues and expenses during a period of time. The purpose of this statement is to provide the financial earnings performance to investors and the most precise description of a company’s profitability. The income statement reports the success or failures of a company’s operations. If the company’s revenue exceeds its expense, it will report net income; otherwise it will report a net loss (Kimmel, Weygandt, and Kieso, 2010, pg. 13). The layout of the income statement sections allows for analyzing the revenues, expenses, operating income, and profits of a company. The retained earnings statement shows the profits or net income generated by a company. It also shows the sums of profits that have been retained by a company since the foundation. This statement is basically used for issuing financial statements to entities outside of a business, for example the lenders and the investors (Kimmel, Weygandt, and Kieso, 2010, pg.13). On the statement, the retained earnings amount can be found on the first line of the statement. The company then adds net amount and deducts dividends to determine the retained earnings at the end of the period (Kimmel, Weygandt, and Kieso, 2010, pg.13). If a company has a net loss, it deducts (rather than add) that amount in the retained earnings statement. The most important purpose of the statement of cash flow is to show the investor how much cash flow into or out of the business over a period of time. It also helps investors, creditors, and others in their analysis of a company’s cash position, the statement of cash flows reports the cash effects of a company’s operating, investing, and financing activities (Kimmel, Weygandt, and Kieso, 2010, pg 15). Another purpose of the statement is to reconcile the income statement and balance sheet. For the income statement, the statement of cash flow reconciles the accounting assumptions with cash the business earns. For the balance sheet, it shows the differences in the level of assets or liabilities from prior reporting periods.
Internal and External Users The internal users of a financial statement are individuals who actually run the business. These individuals are