Financial Statements Paper - Essay Example

Financial ments Introduction The end product in accounting processes would be the presentation of financial statements and reports. Financial statements refer to data summaries prepared by an entity periodically to communicate to respective users of accounting information on the effect of various accounting activities and the entity’s financial position in a given period of time (Fridosn & Alvarez, 2011). They provide information on financial position, financial adaptability and performance of an entity.

Basic financial statements and their purposes A balance sheet, also known as statement of financial position gives snapshot information on the organization’s assets, liabilities and equity of shareholders, as at a particular date. Assets include all the properties of an organization that have value such as inventory, plants, equipment and trucks. It also includes intangible things that have value like patents and trademarks. On the other hand, liabilities refer to the money owed to other entities including obligations such as bank loans, rent, suppliers’ payments and salaries among others.

Shareholders’ equity refer to the balance that belongs to the shareholders after the organization has paid off all of liabilities it owes various entities. Fridosn and Alvarez (2011) represent this as: Assets = Liabilities + Shareholder’s equity On the left hand side of the balance sheet would be the company’s assets while on the right would be its liabilities and shareholders’ equity. An income statement shows the revenue earned by a company in a specific financial period. It captures the expenses and cost of earning these revenues (Anthony, Hawkins & Kenneth, 2003).

At the bottom of the statement would be an indication of the company’s loss or profit over the specified financial period. This statement also captures the earnings per share, EPS which indicates the amount of money that shareholders would get if the net earnings were to be distributed to them in that financial period. The net income would be computed by subtracting expenses from the gross income. Dividing the net income by the outstanding shares gives the EPS. The statement of owners’ equity, also referred to as statement of retained earnings shows the changes in retained earnings.

Income and dividends are the two major influences or retained earnings. It captures the changes in drawings, capital and profit in the specified period. This statement serves as a linkage between the balance sheet and profit and loss account explaining changes on owners’ equity through additional investment by owners and net income which increase equity and withdrawal, dividends and net loss which decrease equity. The fourth financial statement referred to as cash flow statement reports on the inflow and outflow of cash in a company.

While the income statement indicates whether a profit or a loss was made, this statement shows whether cash was generated. This keeps changing over time and below the statement would be an indication of the decrease or increase in cash over the specified financial period. This statement would normally be divided into three parts according to Anthony, Hawkins and Kenneth, A. (2003). The first part, operating activities, analyses the flow of cash from net income or loss. This part reconciles the income statement to show the actual received cash.

The second part would give the cash flow from investing activities, normally from sales or purchase of long term assets like a plant, machinery or property. Finally, the financing activities part would show the cash flowing from financing activities, typically from sales of bonds and stocks or borrowing from banks. This statement shows the ability of generating future positive cash flows and the ability to meet obligations and also pay dividends. Historical cash flow statement indicates on the timing, certainty and amount of cash flows.

Usefulness to internal users Among the internal users of financial statements are business unit leaders, departmental heads, accounting personnel and corporate auditors. The management uses the income statement to determine the dividends to be issued out to shareholders in a particular financial period. Balance sheets help credit controllers in regulating the amount of credit borrowed by an entity to protect it from liquidation. The statement of cash flows informs an entity of its preparedness to meet obligations when they fall due.

Shareholders would be keen to see how their wealth grows as depicted in the statement of owners’ equity. Usefulness to external users By analyzing a company’s cash flow statements, creditors would know whether a company has the ability to meet its obligations hence avoid bad debts on their side. Entrepreneurs would use these statements to determine viable business ventures in a particular market. Investors would use income statements and statement of owners’ equity to determine which entity to invest in and be assured of considerable returns.

Competitors would be informed on the credit period of the successful entities so that they align their strategies accordingly. The government would use these statements to determine the accuracy of taxes paid based on the entity’s financial strength. References Anthony, R. N., Hawkins, D. F. & Kenneth, A. (2003). Accounting texts and cases (11th ed.). New Delhi: McGraw-Hill Publishing Ltd. Fridosn, M. & Alvarez, F. (2011). Financial statement analysis: A practitioner’s guide (4th ed.). Hoboken, New Jersey: Wiley & Sons Inc.