In this section we're going to be looking at the financial statements - the various types of key accounting reports that are generated by an accountant and the accounting system.
What are Financial Statements?
The financial statements are simply the key accounting reports of a business.
These reports provide summarized figures that give an indication of the current financial health of the business as well as its recent financial performance.
The financial statements can be considered the business's scorecard (or scoreboard) - showing how well or poorly the business is doing.
The word statement simply means a report. So the financial statements are simply financial reports.
The Four Financial Statements
Financial statements consist of the following four reports (each of these reports are covered in their own full lesson where we'll look at the format and go over an example for each one):
1. The Income Statement
The income statement is the first of our financial statements.
Also known as the profit and loss statement, it gives an indication of the financial performance of the business during a period of time. It does so by examining incomes and expenses and showing the resulting profit (or loss).
The financial statements are prepared from the information in the trial balance. Return to the lesson on the trial balance if you would like to brush up on this earlier step first.
Objectives of Financial Statements
Financial statements come in various formats and all provide different information. However, they all have one thing in common: they give useful information about a business (or about an aspect of the business) to the reader.
The specific stated objective of the financial statements is:
To show the reader the financial position, financial performance and cash flows of a business.
As mentioned above:
The financial position of the business is shown in the balance sheet.
The financial performance of the business is shown in the income statement.
The cash flows are shown in the cash flow statement.
It will become even clearer how each financial statement shows these aspects of the business as you go through each of the individual lessons in this section.
Users of Financial Statements
We said that the financial statements give useful information about a business to the reader.
But here's a question - who exactly are the readers or users of the financial statements? Who exactly are these reports prepared for?
Remember how I said that the financial statements are like the business's scorecard?
Well, the people who want to see the financial statements are the people that are interested in seeing this business scorecard - the guys who want to know how well the business is doing, including specific details such as its income, expenses, assets, debts, etc.
These people, in rough order of importance, include:
1) Business owners - They have the most direct interest in how well the business is doing. The better the business performs, the more money they make.
2) Business executives - Managers (people employed by the owners to run the business) will get fired if the business performs poorly, or get bonuses if it performs well!
3) Investors - Investors are only going to invest in businesses with good business scorecards showing good potential for growth and profits.
4) The bank - They are interested in the financial statements (the business scorecard) of businesses they have a relationship with. For example, they may want to look at the financial statements to see how risky it would be to loan money to the business.
5) The government and tax authorities - They want to know that the business is fulfilling their legal duties, and in particular, that they are paying enough tax! The financial statements give a good idea of how much tax the business should be paying over.
6) Suppliers - Suppliers want to make sure that they will get paid by the business they are supplying goods to! So they may want to check the financial statements of the business before they even start to do business with them.
7) Employees - Though this is not often the case, an employee may want to know how well the business is doing so he or she can plan for the future. For example, if the business looks like it might fall apart soon, the employee may want to start looking for another job!
Note that the drawing up of financial statements is a compulsory (legal) obligation for public companies- companies that are listed on a public stock exchange - and must be done on an annual basis.
Also, after they are finalized, their financial statements have to be audited - meaning that they must be checked by an independent external auditor for accuracy.
The independent auditors publish an audit report on the accuracy of the financial statements, which is then often included as part of the company's published annual financial statements.
It is customary for all types of corporations to prepare their financial statements annually (not just public companies), but company executives often want them prepared more often for internal uses.
That's the end of our lesson on financial statements.