POINTS TO REMEMBER ABOUT FINANCIAL STATEMENTS

A TUTORIAL ON FINANCIAL STATEMENTS

1. The basic form of the balance sheet is Assets = Liabilities + Owner Equity.

2. Assets are the expenditures made for items, such as Inventory and Equipment, that are needed to operate the business. The Liabilities and Owner Equity ref lect the funds that financed the expenditures for the Assets.

3. Balance sheets show the financial position of a business at a given moment in time.

4. Balance sheets change as transactions are recorded.

5. Every transaction is an exchange, and both sides of each transaction are recorded. For example, when a company obtains a bank loan, there is an increase in the asset cash that is matched by an increase in a liability entitled “Bank Loan.” When the loan is repaid, there is a decrease in cash which is matched by a decrease in the Bank Loan liability. After every transaction, the balance sheet stays in balance.

6. Income increases Owner Equity, and Drawings decrease Owner Equity.

7. The income statement shows how income for the period was earned.

8. The basic form of the income statement is:
a. Sales − Cost of Goods Sold = Gross Income.
b. Gross Income − Expenses = Net Income.

9. The income statement is simply a detailed explanation of the increase in Owner Equity represented by Net Income. It shows how the Owner Equity increased from the beginning of the year to the end of the year because of the Net Income.

10. Net Income contributes to Cash from Operations after it has been adjusted to a cash basis.

11. Not all expenses are cash outflows—for instance, Depreciation.

12. Changes in Current Assets (except Cash) and Current Liabilities are not cash outflows nor inf lows in the period under consideration. They represent future, not present, cash f lows.

13. Cash can be generated internally by operations or externally from sources such as lenders or equity investors.

14. The Cash Flow Statement is simply a detailed explanation of how cash at the start developed into cash at the end by virtue of cash inf lows, generated internally and externally, less cash outf lows.

15. As previously noted:
a. The Income Statement is an elaboration of the change in Owner Equity in the Balance Sheet caused by earning income.

b. The Cash Flow Statement is an elaboration of the Balance-Sheet change in beginning and ending Cash.

Therefore, all three financial statements are interrelated or, to use the technical term, “articulated.” They are mutually consistent, and that is why they are referred to as a “set” of financial statements. The threepiece set consists of a balance sheet, income statement, and cash flow statement.

16. A set of financial statements can convey much valuable information about the enterprise to anyone who knows how to analyze them. This information goes to the core of the organization’s business strategy and the effectiveness of its management.

1 comment:

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