Financial Statements Kaylie McGinn ACC/290: Principles of Accounting 1 Michael Arnone June 18, 2012

Financial Statements Financial statements are various reports created about a businesss financial condition and the financial results. Financial statements are essential to determine the businesses ability to generate a profit, the sources and the uses of cash, the ability to pay back debts, track any trends that may lead to financial problems, and plan for the future. There are four main financial statements: balance sheets, income statements, statements of cash flow, and retained earnings statements. Balance Sheet The balance sheet reports a firms assets, liabilities, and owners equity on a specific date. According to Kimmel, Weygandt, and Kieso (2010), balance sheets obtained their name because it confirms that the accounting equation has remained in balance. This means the balance sheet should show that assets equal the liabilities of the business plus the stockholders equity (p. 14). The balance sheet displays the businesses assets, liabilities, and the equity of the business. Assets The assets listed include current assets and long-term assets. Current assets are expected to be converted into cash or used by the business within a year or operating cycle. Current assets include cash and other monetary assets, including accounts receivable, inventory, market securities, and prepaid expenses. Long-term assets are the assets whose benefits are expected to come about in a year or more. Long-term assets include long-term investments, operating assets, such as equipment, and intangible assets such as patents and trademarks. Liabilities

Liabilities are both the current liabilities and the long-term liabilities. Current liabilities are those that will be paid utilizing the current assets. Current liabilities are accounts payable such as, to vendors, wages, rent, and taxes. Long-term liabilities are things like pensions and long-term leases. Owners Equity The owners equity is derived from two sources: contributed capital and retained earnings. Contributed capital is usually made up of common stock but can also include preferred stock. Retained earnings are the net income that has been held back by the business after the payment of dividends (return on investments paid to stockholders). Income Statement Income statements report the profitability of business operations for a specific period. Income statements report the net income or the net loss of a business. The basic equation used to demonstrate this would be the revenue minus the expenses of the business will yield the net income or the net loss depending on if the revenues exceed the expenses or not. The key elements of an income statement are revenues, expenses, gains, losses, and net income or net loss.

Revenues Revenues are the total amount earned by selling the products or services provided by the business during a specific time period. This may include the sales, fees, and earnings from

interest, dividends, lease income, and royalties. Net sales are the sales listed and are the value of the businesss sales of goods and services minus the returns and allowances and discounts.

Expenses Expenses are the costs am entity incurs for doing business in a specific period of time. These expenses include the costs of materials, supplies, labor, leases, and utilities. Expenses must also directly relate to generating revenues for an entity. Cost of sales includes the costs of manufacturing, supplies, and labor used in the production of the goods. The cost of sales is calculated by the adding together beginning inventory and purchases and subtracting the ending inventory. Selling, general, and administrative expenses are the companys operational expenses. Selling expenses are the expenses generated by the selling and marketing of the products.

Gross Profit, Gains, and Losses Gross profits or gross margin is the difference between net sales and cost of sales. Gains are from peripheral or incidental transactions of the business. Losses are decreases in the owners equity from the peripheral or incidental transactions of the business.

Net Income

Net income is the excess of all revenues and gains for a designated period over all expenses and losses of that period. A net loss is the excess of expenses and losses over revenues and gains for a designated period.

Statements of Cash Flow

Statements of cash flow show the amount of cash collected and the amount of cash paid out by the business over a specific period of time regarding the operating, investing, and financial activities of the business. This statement is generated to cover the same time period as the income statement. The statement of cash flow places all cash exchanges into one of three categories operating, investing, or financing to calculate the net change in cash during an accounting period. Statements of cash flow focuses on the cash flow rather than income.

Operating Cash Flows Operating cash flow comes from the day-to-day business operations such as, inventory purchases, sales revenue, and payroll expenses. Interest, dividends, interest payments, and income taxes are also reported under operating cash flow.

Investing Cash Flows

Investing cash flows relate to cash exchanges involving long-term assets, such as purchase or sale of land, buildings, equipment, or long-term investments in another companys stock or debt.

Financing Cash Flows Financing cash flows involve changes in long-term liabilities and owners equity. This includes receipt or early retirement of long-term loans, the sale or repurchase of stock, and the payment of dividends to shareholders.

Retained Earnings Statements

Retained earnings statements are showing the amounts and causes of changes in retained earnings during the period (Kimmel, Weygandt, & Kieso, 2010, p. 14). Retained earnings statements are created for the same period as the income statement. The retained earnings statements start with the beginning retained earnings balance. The net income is added and the dividends are deducted to determine the current retained earnings. The retained earnings statements are meant to summarize the changes in the retained earnings over a specific period of time. Usefulness of Financial Statements Financial statements have both internal uses and external uses. The key internal users are business owners and managers. They use the information in the financial statements to determine

the businesss profitability and current condition and to measure the businesss performance. If the business is doing well the owners may wish to make additional investments toward growth and if it is poor find areas to cut or close the business altogether. Managers use it to make operating decisions such as how much and what kinds of inventory to carry and if they can hire more employees or offer raises. The primary external users are creditors and investors. Creditors use the information in the financial statements to determine the businesss profitability, current debts, and the assets available to pay debts. This aids creditors in determining if the business qualifies for a loan and for how much and what interest rate to charge. Investors use financial statements to determine if they should invest by looking at the business trends and profitability.

References Kimmel, P.D., Weygandt, J.J., & Kieso, D.E. (2010). Financial accounting: Tools for business decision making (5th ed.). Retrieved from The University of Phoenix eBook Collection database.