Brief Overview Of 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 reflect 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:

• Sales - Cost of Goods Sold = Gross Income.
• 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 neither cash outflows nor inflows 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 inflows, generated internally and externally, less cash outflows.
15. As previously noted:

• The Income Statement is an elaboration of the change in Owner Equity in the Balance Sheet caused by earning income.
• 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 three piece 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.
Analyzing the projected financial statements in order to make her recommendation to the
bank’s loan committee about loan application. Special attention to the Cash Flow Statement should be given, keeping handy the bank’s guidelines on cash flow analysis, which included the following issues:

• Is cash from operations positive? Is it growing over time? Is it keeping pace with growth in sales? If not, why not?
• Are cash withdrawals by owners only a small portion of cash from operations?
If owners’ cash withdrawals are a large share of cash from operations, then the business is conceivably being milked of cash and may not be able to finance its future growth.
• Of the total sources of cash, how much is being internally generated by operations versus obtained from outside sources? Normally wise businesses rely more on internally generated cash for growth than on external financing.
• Of the outside financing, how much is derived from equity investors and how much is borrowed? Normally, a business should rely more on equity than debt financing.
• What kind of assets is the company acquiring with the cash being expended?
Are these asset expenditures likely to be profitable? How long will it take for these assets to repay their cost and then to earn a reasonable return?

Who Uses Them And Why:

Here is a brief list of who uses financial statements and why. This list gives only a few examples and is by no means complete.

1. Existing equity investors and lenders, to monitor their investments and to evaluate the performance of management.
2. Prospective equity investors and lenders, to decide whether or not to invest.
3. Investment analysts, money managers, and stockbrokers, to make buy/sell/hold recommendations to their clients.
4. Rating agencies (such as Credit Rating Information Services of India Limited (CRISIL),
Investment Information and Credit Rating Agency of India (ICRA), Credit Analysis & Research Limited (CARE)), to assign credit ratings.
5. Major customers and suppliers, to evaluate the financial strength and staying power of the company as a dependable resource for their business.
6. Labor unions, to gauge how much of a pay increase a company is able to afford in upcoming labor negotiations.
7. Boards of directors, to review the performance of management.
8. Management, to assess its own performance.
9. Corporate raiders, to seek hidden value in companies with underpriced stock.
10. Competitors, to benchmark their own financial results.
11. Potential competitors, to assess how profitable it may be to enter an industry.
12. Government agencies responsible for taxing, regulating, or investigating the company.
13. Politicians, lobbyists, issue groups, consumer advocates, environmentalists, think tanks, foundations, media reporters, and others who are supporting or opposing any particular public issue the company’s actions affect.
14. Actual or potential joint venture partners, franchisors or franchisees, and other business interests who need to know about the company and its financial situation.

This brief list shows how many people and institutions use financial statements for a large variety of business purposes and suggests how essential the ability to understand and analyze financial statements is to success in the business world.