Financial statements paper - Essay Example

Accounting is one of the most important branches in business administration. The term accounting can be defined as an information system that identifies, records, and communicates the economic events of an organization to interested users (Weygandt, Kieso, Kimmel, 2002). Accounting information can be used by both internal and external users. Accountants must comply with the general accepted accounting principles (GAAP). The general accepted accounting principles were developed by the FASB in 1973 (Balle, 2013).

The accounting cycle ends with the creation of the financial statement of the company. The financial statements must be published in the annual report of publicly traded companies. The four financial statements are the income statement, balance sheet, statement of retained earnings, and the statement of cash flow. The income statement is a financial report that measures the profitability of a company. The first number reflected in the income statement is the total sales or revenues. Sales are very important because they are used to pay for the expenses of an organization.

The cost of goods sold is subtracted from revenues to arrive at the gross profit. Gross profit is a broad measure of the profitability of a firm. The list of expenses of the firm is tabulated in the bottom part of the income statement. These are subtracted from gross profit to arrive at the net income. Net income measures the absolute profitability of an enterprise. An income statement calculates net income for a financial period which typically covers one year. Companies make money when its revenues exceed its expenses.

The balance sheet is considered a statement of the financial position of a company at a specific point in time. The three main components of the balance sheet are assets, liabilities, and stockholder’s equity. The basic accounting equation states that assets equal liabilities plus stockholder’s equity (Quickmba, 2013). The top part of the balance sheet is the asset section. Assets are listed in this section subdivided as current and long term assets. The bottom part of the balance sheet is the liabilities and stockholder’s equity section.

Liabilities in this section are subdivided into current and long term liabilities. The statement of retained earnings reflects the changes in retained earnings during the year. The different financial statements are interrelated. The first input in the statement of retained earnings is the initial balance of retained earning at the beginning of the year. The net income from the income statement is added to the initial retained earnings balance. If the company incurred in a loss then the figure is subtracted.

The last step is to deduct cash or stock dividends declared to then arrive at the retained earnings ending balance. The last financial statement is the statement of cash flow. The statement or cash flow lists the cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities during an accounting period (Weygandt, et al. 2002). Cash is the most valuable asset of a company due to the fact that it is 100% liquid. All of the financial obligations of a company are paid with cash.

The information contained in financial statements can be very useful for external users such as banks, suppliers, and investors. Banks use the financial statements to evaluate the credit worthiness of a firm. Suppliers use the information from financial statements to determine whether a company is a good candidate to establish a long term relationship. Investors evaluate the financial condition of a company to make buy or sell decisions of the common stocks of a public firm. A financial technique that can be used to evaluate the financial performance of a firm is ratio analysis.

All the input to calculate financial ratios comes from the financial statements. The five categories of financial ratios are liquidity, profitability, leverage, activity, and market ratios. Internals users such as the managerial staff of a firm can benefit from the information provided within the financial statements of a company. For instance if the income statement reflects that the profitability of the firm is low, managers can take actions such as lowering material costs in order to improve the firm’s profitability.

Calculating the current and debt ratio of a firm can help a manager determine if a company is in a good position to pay off its short term and long term debt. Information from the financial statements can be used by managers to assess whether the company can undertake any capital projects. Pricing decisions of products can be established based on the results of the financial statements. References Balle, L. (2013). Who Founded the GAAP? Retrieved December 5, 2013 from http://www.ehow.com/about_4706103_who-founded-gaap.

html Quickmba.com (2013). The Accounting Equation. Retrieved December 5, 2013 from http://www.quickmba.com/accounting/fin/equation/ Weygandt, J., Kieso, D., Kimmel, P. (2002) Accounting Principles (6th ed.). New York: John Wiley & Sons.