The Four Major Financial Statements - Essay Example

The business community has more accumulated wealth that the governments of the over 200 countries in the world combined. There are thousands of publicly traded companies been traded on Wall Street and international markets such as the London Stock Exchange every day. Due to the importance of these capital markets there is a need for professionals dedicated to financial reporting. Publicly traded companies have to prepare financial statements every accounting period. The normal accounting period is one year, but most companies also release quarterly financial statements. The four major financial statements are the income statement, balance sheet, statement of cash flow, and statement of stockholders equity. These four financial statements are included in the Annual Report of corporations. The purpose of this paper is to analyze and describe the income statement and the balance sheet. The income statement and the balance sheet are two interrelated statements. The outcome of the income statement affects the equity account of the balance sheet. The income statement is a financial report that provides information regarding the profitability of the company during an accounting period. The top figure in the income statement is sales. Sales are very important because they provide the economic asset needed to operate a business. The sales of the company are subtracted by the cost of goods sold. The subtraction of those variables is the gross profit. At the bottom of the income statement the operating expenses and taxes are subtracted from gross profit to arrive at net income. The income statement is a very valuable report because it indicates how well a business operation is doing in terms of financial success. The income statement reports the revenues and expenses of an enterprise during a natural or fiscal year. The top and bottom figures of the income statement are the two numbers investors look for which are sales and net income. The higher the figure of net income the better off a company is financially. Net incomes help companies accumulate capital. The net income figure is transferred from the balance sheet to the stockholder’s equity section. The second major financial statement is the balance sheet. The balance sheet is considered a statement of position. This means that the figures illustrated in the balance are the account balances at a specific point in time. The three major components or categories within the balance sheet are assets, liabilities and stockholder’s equity. The internal structure of the balance sheet follows the logic of the basic accounting equation. The basic accounting equation states that assets are equal to liabilities plus stockholder’s equity. An asset can be defined as an item of economic value owned by an individual or corporation (Answers, 2011). The assets in the balance sheet are listed in order to liquidity. The most liquid asset is cash. Equipment and machinery are two examples of assets. Machinery is a fixed asset that can be used to generate revenues. Assets can also be converted to cash by selling them. The liabilities of a company are short and long term obligations to financial institutions such as banks. It is preferable for a company to have a low level of debt. Debt instruments can be used to finance expansion projects. The debt section of the balance sheet is divided into short and long term liabilities. The last segment of the balance sheet is the equity section. The balance sheet and the income statement are prepared once the accounting department completes the accounting cycle. These two financial statements are extremely valuable pieces of information for the user of financial information. It is mandatory for public companies to release the financial statements at least once a year. The regulatory agency that foresees the financial actions of public corporations is the Securities and Exchange Commission (SEC). The data in the balance sheet and income statement can be used by financial analyst or anyone with financial knowledge to perform ratio, trend, and variance analysis. The net margin is one of the common profitability ratios. It is calculated using data contained in the income statement. The formula is net income divided by sales equal net margin. The debt ratio can be calculated extracting data from the balance sheet of a company. The formula is total assets divided by total liabilities. The return on assets (ROA) and return on equity (ROE) can be calculated using the income statement and the balance sheet. ROA is calculated dividing net income by total assets and ROE by dividing net income by total equity. The information in the balance sheet and income statement can be used to further analyze the financial state of a company by performing trend analysis. Trend analysis compares the performance of a company with the performance of the same company in a previous period. For example a company generated in 2009 $10 million in sales, but 2010 the sales of the firm were $12 million. The company in 2010 sold 20% more than in 2009. Variance analysis compares the budgeted results with the actual results of a company. These analyses are performed using data and information from the income statement and balance sheet. The educational system of America must begin to provide a better understanding of financial information so students can be better prepare to deal with their finances. Two accounting reports that provide lots of information regarding the profitability and financial position of a company are the net income and the balance sheet. These reports are prepared through the application of financial accounting. These reports are very valuable tools for all the stakeholder groups that use financial information which includes employees, lenders, investors, the community, government, and the managerial team. The managers of a company are responsible for the employees and for the financial performance of an organization. Managers can utilize the income statement and the balance sheet to evaluate the performance of the company during a particular period of time. The software accounting packages utilized by multinational corporations such as Peachtree Accounting are able to generate income statements on a monthly, weekly or daily basis. This up to date information is very valuable for managers to make operating decisions. References Investorwords.com (2011). Asset., Retrieved March 20, 2011 from http://www.investorwords.com/273/asset.html Read More