Accounting / Bookkeeping Basics: Key Financial Statements

Key Financial Statements

Financial statements are, ideally, a record of all transactions and financial activities that took place within a fiscal year. The statements are a representation of the financial performance, strength, and liquidity of a company. Notably, there is no financial statement that is more important than another. All statements must be used together to make conclusive inferences about the position of a company. First things first, why are financial statements important, and who are their users?

Users of Financial Statements
Typical financial statements have very many users, some of whom include:

- The Management
Any company official is interested in the manner through which the company is operating and, most certainly its financial position. As is evident, all companies are in the market for the sole purpose of making profits. Therefore, it would be in the best interest of any manager or company owner to run a business that s stable and is making profits. The only way through which the company can know how it performed is through the analysis and evaluation of the final books. Making a profit and being financially stable is the most appropriate situation, and the management is able to determine this from the financial books.

- Investors
One of the golden rules of money is that you must always attempt to invest in a place where you are sure that you will reap benefits in the future. When companies go public, it is an investment opportunity, and most investors will most likely try to seek the viability of the opportunity to see if it is feasible enough for them. The only way through which they can make a conclusive judgment is if they thoroughly check the financial documents to ensure the extent to which the company is stable. The financial statements also contain non-financial information that helps investors make further decisions. Such information includes competitors, government policies and other external industrial factors. In as much as such information may seem trivial, the truth is that it really affects the positioning and functionality of the company to a very large extent and maybe a major determinant concerning the level to which the company will succeed.

- Competitors
There are competitors in every industry. Competitors are major drivers in every industry since the fact is that all companies fight for the same end consumers. The profitability of any company is determined by its competitive advantage, and the more competitive it is, the higher the chances of getting and retaining clients. Note that financial statements are not private. Most companies are required to publish all of their final books of accounts in gazettes and report them accurately. Any member of the public has access to these books. Therefore,  competitors tend to analyze each other’s final books of accounts and compare them with their personal ones to try and gauge the level to which such competitors are above them. For example, a competitor may be interested in the number of sales and revenue that a company got from a particular product. If the sales are much higher than what they managed to achieve, it may be time to call a board meeting to determine what is being done wrong and what can be improved. Also, some statements contain an analysis of the future prospects of the company, and the competitors can steal ideas therein.

- Government
The government is undoubtedly one of the major enthusiasts and users of financial statements. One of the major reasons as to why they keep so many tabs on companies is to review the taxes and predict future tax prospects. For example, if most companies in a certain industry continue showing upward growth, it is a sign that the government can expect to collect more taxes. Likewise, when most companies are seemingly collapsing and making losses, the government can expect reduced remittance in the next financial year. A review of different countries’ financial books has been a contributor to changed government policies in some instances. When companies are collapsing, the government is able to conduct more studies to help reveal why such an occurrence is prevalent, and if it is something that they can control, they do so. In a perfect setting, the government would wish for all companies and businesses to be performing  well.

- Employees
Employees are also considered to be critical users of financial statements for the main reason that the performance of the company directly affects them. Whenever a company is not doing well, employees should be very careful since there they can potentially lose their jobs. Likewise, when a company is doing well, the employees will be motivated to do even better, and the peace of mind through the knowledge that their jobs may be secure helps immensely.
Currently, there is an upcoming project management and governance model known as agile, whose basis is the involvement of employees in all company functions. In this case, the employees are mandated to take full responsibility for the performance of the company, and they have to scrutinize the books to determine why the performance is as revealed.

- Lenders
One of the things that lenders try to avoid as much as they can is suffering bad debts. Bad debts are a very common occurrence, and the fact usually is that there is no way that the lenders can recover the amount owing. To prevent this extremity, lenders always try to ensure that they properly scrutinize potential lenders to determine the level to which they can be assured that the debt will be repaid. Stable companies have a very high likelihood of payment, while struggling companies may just end up not paying at all.

- Suppliers
Just like the lenders, suppliers often need to know the possibility of the company paying them for goods supplied. As is common in most companies, suppliers use their own money to serve tenders and other supply needs, and they are paid in bulk on a pre-determined basis. In case the companies fail to pay them, the suppliers end up losing stock as well as the capital used to finance the business. Supplies may run into millions of dollars, which means that failure to pay potentially crushes such persons. Therefore, there is always a need to carry out due diligence to prevent such potential eventualities.

- General Public
The general public is also a major user of financial statements. There are so many other groups of people who have varied reasons for seeking books, and no one can stop them from accessing such information. For instance, students may be involved in different types of research, warrantying the need for the statements. Also, entrepreneurial enthusiasts may go through different accounts just to try and seek any information that may help them to make conclusive decisions about how they should proceed in their quest.

Types Of Financial Statements
Financial statements are written accounting records that represent an entity’s financial activities, thereby showcasing their strengths, liquidity, etc. The financial statements comprise a summary of the strength, performance, and liquidation status of a company. It is mandatory for every company to create these financial statements at the end of every  fiscal  year.  

The  three  main financial statements are;

Balance sheet
The balance sheet is also known as the statement of a financial statement. This statement illustrates the financial position of an organization at a given time. This statement is usually prepared at the end of an accounting period and is prepared using the historical cost principle.
The key elements of the balance sheet are assets, liabilities, and equity. Assets refer to the tangible and intangible resources that are owned by the company. Liabilities, on the other hand, refer to the company’s obligations. Finally, equity refers to what an organization owes its owners, and is the difference between the assets and the liabilities.
The balance sheet follows the accounting equation, and it must always balance. Before you prepare a balance sheet, there is always a need to prepare a trial balance first, identify and summarize all the accounts involved, and finally prepare the book.

A sample balance sheet is as illustrated below:

As you can see, the three elements of accounting are clearly illustrated. There are assets, liabilities, and owner’s equity. Note that there are many transactions that occur in a typical company, and the truth is that not all of them are illustrated in the balance sheet. Keep in mind that the balance sheet items only include the three elements of accounting. Therefore, you may want to begin by identifying all of the fixed and current assets,  short- and long-term liabilities, and the owners’ equity.Ultimately, the figures  must balance. In this case, the balancing amount is $186,500
Also, note the manner in which the balance sheet is prepared. The title is always centered and written in three lines. The first line is the name of the company, the second line an illustration that it is a balance sheet, and the third line the accounting period. That is the order, and you must always abide by it.

Income statement
The income statement is also referred to as the profit and loss statement, which ideally showcases the performance of the company through the analysis of the net profit or loss realized.
The key elements in the statement are incomes, which represent what a company has earned over a particular time and expenses, which illustrate the costs incurred by the business over a certain period. The difference between incomes can either be positive or negative, where the former indicates profits while the latter indicates losses. 

An illustration of a profit and loss statement is shown below:

Just as with the balance sheet, the heading has three lines. To properly prepare an income statement, keep the following pointers in mind;
- The fact that the statement is referred to as a profit and loss account is an illustration that its main role is to determine whether a company made profits or losses in a certain period.
- To get the final figure, deduct expenses from revenues. A positive balance denotes a profit while a negative balance denotes a loss.
- Always use the accrual basis of accounting when preparing the income statement.

Cash Flow Statement
The cash flow statement summarizes the flow of cash and cash equivalent, and show the movement of cash over a specified period of time. The term cash and cash equivalent mean “similar to,” which means anything that can be compared to cash. Some popular examples of cash and cash equivalent are:
- Stocks
- Certificates of deposit
- Shares

Once you have identified all of your cash and cash equivalents, you can proceed to prepare this financial statement.

The key elements of the statement are operating activities, investing and financing activities.
- Operating activities are the revenue generation activities that include activities such as the sale and purchase of goods and services. Therefore, they are activities that serve as the main revenue-generating processes. To put it simply, the revenue-generating activities are the sole reason for which the company was created. For instance, if you have a t-shirt selling shop, the operating activities will revolve around buying raw materials and selling the shirts on either a cash or credit basis.
- Investing activities are those activities that have the intention of generating income in the future, such as the purchase and sale of long-term assets. Many companies do not only operate within themselves, and they buy stocks and shares from other companies to increase their stability.
- Finally, financing activities represent the acts that influence cash flow from the company’s securities. Any financing activity is mostly centred on the movement of cash for the sole purpose of financing all of the business operations.
These are the main financial statements that are released by a typical company. However, there are other small statements that may either be prepared or not depending on what the company wants to evaluate. Some of the minor accounts include the statement of shareholders' equity as well as general reports.