Financial Statement Differentiation
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According to the Generally Accepted Accounting Principles, business entities are obliged to report information about their activity using four different kinds of reports to claim financial aspects of their performance. Reports are submitted on a periodical basis and include the following financial statements: income statement that represents the difference between revenues and expenses for a specific time period; balance sheet that is a statement of the firm’s financial situation at a given date; equity statement that is also known as a statement of retained earnings or statement of owner’s equity; and finally, statement of cash flows that provides summary information about the movement of incoming and outgoing cash flows during a specific period (Mostyn, 2008).
The income statement is a financial report that provides information about the results of the firm’s operations for a specific period of time. Usually, income statements are reported on an annual basis. The income statement includes information about revenue items, as well as expense items, that were incurred to earn revenues. Therefore, reported result of the operational activity of a firm shows either net profits (if revenues exceed expenses) or net losses (if expenses exceed revenues). At the same time, income statements also provide information about income per share showing the rate of shareholders’ earnings.
The balance sheet provides detailed information about the firm’s assets, liabilities, as well as equity of shareholders. Assets represent the value of the company’s possessions that can be sold and used to produce goods or services. They include physical property, trademarks, patents, cash, and other claims. On the other hand, liabilities are the firm’s obligations to other entities, including different kinds of credits, rental payments, money owed to firm’s suppliers or other stakeholders, as well as taxes that firm owes to the government. Finally, shareholders’ equity, which is reported in the balance sheet, represents the firm’s value that is often referred to as the firm’s capital. It shows the amount of money that would be left after paying all liabilities using available assets (Mostyn, 2008).
Next, the statement of owner’s equity provides information about changes in the retained earnings. Retained earnings are reported in the balance sheet and are generally determined by the amount of dividends paid and the income level. Therefore, the owner’s equity statement uses the information reported in the income statement (net income) and in the balance sheet (the prior balance of the retained earnings), and the new amount is ultimately reported in the current balance sheet.
Finally, the cash flow statement reports the firm’s inflows and outflows of cash during a certain period. In general, the cash flow statement is divided into three major parts depending on the nature of business activities: operating, investing, or financing. Primarily, the cash flow statement provides information about the changes of cash flows over time rather than absolute amounts of cash flows (Mostyn, 2008).
Different types of financial statements provide different information that can be interesting for various stakeholders. In particular, investors are interested in the income statements since they provide information about the firm’s level of profits that determine dividends for investors and shareholders. At the same time, investors can analyze how the firm’s profit has been changing over time, as well as compare it to other firms’ profits, and make final decision whether they should make investments or not. Furthermore, creditors are more interested in the balance sheet of a company that either confirms or disapproves the ability of a firm to pay off the credit. Finally, firm’s management is interested in the analysis of all kinds of financial statements to find spheres that require improvement (for example, items of expenses that can be reduced).
To sum up, it should be noted that financial statements reported by business entities provide useful information to different kinds of interested parties. These statements help them make decisions with respect to firms’ activities on the market.
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