What Is A Financial Statement?
A financial statement is a report containing financial information about a company. The financial statement depicts the condition and performance of the company. Generally, the financial statement consists of the balance sheet, income statement, statement of cash flows, and statement of changes in owner's or stockholder's equity.
A balance sheet is a statement of the company's assets, liabilities, and equity at a specific point in time (sometimes referred to as a "snapshot"). The balance sheet shows, in dollars, what the business owns (assets), what it owes (liabilities), and its owners' ownership interest (equity or net worth) at a given point in time. The income statement reflects the performance of the company over a specified period of time in terms of revenue, expenses, and net income or loss. The statement of cash flows provides relevant information about cash receipts and cash payments of the company during a specified period. The statement of changes in owner's or stockholder's equity discloses the changes in these separate accounts and is meant to make the other financial statements as informative as possible.
Monitoring your company's financial statements can provide you with information that is useful in making credit and investment decisions; assessing future cash flows; and understanding the company's resources, claims to those resources, and any changes in them. For optimum benefit, financial statements should be monitored on a monthly basis. Most likely, you will have an accounting professional prepare the financial statements for you. However, in order to make your company's financial statements work for you, you need some basic knowledge. What follows are a few simple accounting principles to give you at least a conceptual framework.
Tip: Financial statements are not just internal company tools. Creditors, investors, and potential purchasers are often quite interested in seeing your financial statements. Additionally, all corporations and certain partnerships are required to attach these reports to income tax returns (Forms 1065, 1120, and 1120S).
Tip: You may want to have your financial statement audited regularly by a reputable certified public accountant. If you own a small business, you may need to do this only every few years. However, if you own a larger organization, or one with complex operations or several locations, an annual audit is recommended.
What Are The Elements of Financial Statements?
There are 10 basic elements of financial statements. They are:
An asset is something the company owns. Specifically, assets are probable future economic benefits obtained or controlled by your company as a result of past transactions or events.
A liability is something the company owes. Specifically, liabilities are future sacrifices of economic benefits arising from present obligations of your company to transfer assets or provide services to other entities (companies or persons) in the future as a result of past transactions or events.
Equity is an ownership interest. Specifically, equity is the residual interest in the assets that remains after deducting your company's liabilities.
Investments by Owners
An increase in net assets resulting from transfers of value made by others in order to obtain or increase ownership interests (i.e., equity) in the company is an investment by owners. Usually, assets are received, but services, satisfaction or conversion of company liabilities may also be used.
Distributions to Owners
A decrease in net assets resulting from transferring assets, providing services, or incurring liabilities to owners is a distribution. Distributions to owners decrease their ownership interest in the company.
Broadly speaking, comprehensive income refers to net operating profit. Specifically, comprehensive income is the change in equity during a period of transactions with non-owners.
Broadly speaking, revenues refer to gross operating profit. Specifically, revenues are inflows or other enhancements of assets, (or reductions of liabilities) during a period of delivering or producing goods, providing services, or otherwise carrying out the business of the company.
The flip side of revenues--expenses--are the company's operating outflows (i.e., the using up of assets), or incidence of liabilities, during a period of delivering or producing goods, providing services, or otherwise carrying out the business of the company.
A gain is an increase in equity from all transactions other than operations.
The flip side of gains--losses--are decreases in equity from all transactions other than operations.
What Is The Historical Cost Principle?
Most assets and liabilities are recorded on the company's books at historical cost. That is, they are recorded on the basis of acquisition price. It is done this way because historical cost is reliable and verifiable. What this means, however, is that assets and liabilities do not reflect current value. Therefore, you must keep in mind that the asset or liability may be undervalued or overvalued in terms of current market value.
What Is The Revenue Recognition Principle?
Revenue is generally recognized when it is realized (or realizable) or when it is earned. Revenue is realized when products or services are exchanged for cash. Revenues are realizable when assets received for products and services are readily turned into cash. Revenues are considered earned when the company has substantially accomplished what it must do to receive the cash. In other words, revenue is not put on the books until the sale is actually made. It is a uniform and reasonable method of accounting. This rule is followed to give meaning to revenue numbers on the financial statement. You can be sure the revenue is real and not dependent on an anticipated sale that may not actually take place.
What Is The Matching Principle?
The matching principle means that expenses follow the revenues. Expenses incurred in the performance of the work are recognized only when the product actually makes a contribution to revenue. For example, wages paid and inventory and supplies used to build a widget are not recognized until the widget is sold. Wages paid and inventory and supplies used (and other such expenses) are classified as product costs. They relate directly to the making of the product. However, period costs, such as officers' salaries and selling expenses, are charged off immediately because no direct relationship between cost and revenue can be determined. Thus, be aware that some expenses may not be reflected in the financial statement.
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