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The Three Most Common Financial Reports
3 Most Common Financial Reports
- Balance Sheet
- Income Statement
- Statement of Cash Flows
Accounting Equation Explained
The accounting equation forms the basis for the whole accounting process. At all times, the accounting equation, assets = liabilities plus owner’s equity must balance or the whole accounting system is off. Assets are what a business owns; cash, equipment, buildings, inventory, land, and other resources, and liabilities are what debts a business owes. The difference between assets and liabilities are the owner’s equity, or net worth. Within this accounting cycle, there are certain important financial reports. The three most common are; the Balance Sheet, the Income Statement, and the Statement of Cash Flows.
Balancing The Books
The balance sheet, or a statement of financial position, refers to the financial report that demonstrates the accounting equation, which is assets equal liabilities plus owner’s equity. The balance sheet can be presented in a vertical form, the report presentation, or it can be presented in a horizontal form, which is the account presentation. Either way, there are five sections of information that must align with the accounting equation. The five subsections are as follows: current and noncurrent assets, current and noncurrent liabilities, and shareholder/owner’s equity. The terms short and long term can also be substituted for current and noncurrent. The balance sheet is a snapshot of the company’s financial health at a certain point in time.
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Because the asset side of the equation is listed from most to least liquid, the company is able to tell how much cash it can have available in a relatively short period of time. It is also able to determine if it has too much debt or if it is able to pay off it’s liabilities. A company should use the balance sheet to make sure that the accounting formula is accurate and balanced. The acid test ratio, also called a quick ratio, and the current ratio can be used along with the balance sheet to determine the company’s ability to pay off debt quickly in case of a catastrophe. In addition, the balance sheet can help determine how much working capital a company may have at it’s disposal.
Important Financial Reversal
Business Income Statement
The business income statement records the incoming revenue, the cost of goods and the expenses of a company for a certain amount of time such as monthly or quarterly. It also reflects the total loss or profit for that period of time. It can also be called the earnings statement or the statement of revenue and expenses. This report lets the company know how much debt it is carrying and how much net income it receives after all debts are paid. The profitability ratio is used as a measure of how well managers use the resources available to them. It helps to determine how much return is earned on the cost of goods sold, return on equity, and the return on each share. If the profitability ratio is too low, then changes must be made. Additionally, if inventory is not turned over quickly enough, then sales must be improved or inventory must be reduced.
The statement of cash flows reveals how each business activity affects the company’s cash flow for the year. There are a number of activities that must be considered, operating, investing, and financing activities. Because cash is vital to all businesses, the statement of cash flows is of great importance. The first section of the report details the company’s primary revenue source, it’s operating activities. The second section concerns the company’s investment revenue, such as equipment and real estate, and the third relates to finance activities; as in loans, stocks and cash dividends. The beginning cash balance plus the net increase of cash is equal to the ending cash balance.
There are other financial reports that many businesses use, such as The Statement of Owner's Equity, but these are three of the more common ones. The ratios present a clear indication of the business’s financial health and they are important to the everyday operations of many businesses. Using them all together is a good way to present financial information to stock holders, investors, and the public.
All of this comes together to show the financial ability of the company to pay debts and to finance new growth. If the net income is less than the past year, then changes must be made in order to stay in business. The debt to owner’s ratio is a good indicator of how well a company is doing. This ratio is indications of how much debt a company is carrying and of how much of the company’s operations are financed. The ratio is calculated by dividing total liabilities by the owner’s equity. The higher the ratio, the more risk a lender is taking. This problem can be eliminated by paying down some of the debt or by an infusion of cash into the business.
© 2014 Mary Krenz