Explain the various financial statements like balance sheet, income statement, and statement of cash flow and owner’s equity with its advantages and disadvantages of preparing this statement with an example. Financial statements provide information of value to company officers and various external parties, such as investors and lenders of funds. Publicly owned companies are required to publish general-purpose financial statements that include a balance sheet, income statement, and statement of cash flows.
The balance sheet is presented in two sides on the left and right. The left side is called the asset side where it shows the resources owned by the company. Assets are break into current and fixed. Current assets normally have a life span of less than a year and it will be easily converted to cash. Such assets normally include account receivables, cash, prepay expenses and inventory. Fixed assets are assets that are not easily convert to cash within a short period of time. They could be tangible assets like equipment, fixture and fitting, machinery, building and land.
Intangible assets would be assets that are not physical but has valve in it such as copyrights, patents and goodwill. The right side of the balance sheet is called equity and liabilities side, presenting the amount of figure of liabilities. Similarly to the asset side, it has current and long term liabilities. Shareholders' equity is the initial amount of money invested into a business by the shareholders or partners. The advantage of reading a balance sheet is that it presents the immediate financial position of the business by showing assets and liabilities of the concern on a specific date.
In comparing past balance sheets with the present balance sheet, the growth or decline of the business assets, loans and net worth can be determined instantly. It discloses the solvency of business by showing how much assets are available for payment of liabilities. However, Balance sheet does not give accurate picture on real time basis since outdated valued of assets is used, the use of estimate of value and omission of intelligence like the model and business of the company depended on its success whether on its fixed assets or its human resources.
Income statement is also known as profit and loss statement, earnings statement, operating statement or statement of operations. It is a company's financial statement that shows how the revenue is transformed into the net income, it shows the financial position over a period of time. This amount of time could be in per month, quarterly, half a year, or even a year. This contrasts with the balance sheet, which represents a single point of time. Though this statement, it gives the management guidelines in their decisions about future business strategies. Below is an example of an Income statement,
Profit & Loss Statement for DEF Company ended 31 Dec 2009 S$ Gross Sales 700,000 Less returns 10,000 Net Sales 690,000 Cost of Goods Inventory, Jan 1 400,000 Purchases 300,000 Less Inventory, Dec 31 250,000 Cost of Goods Sold 450,000 Gross Profit 240,000 Less Expenses Salaries 67,200 Utilities 12,000 Rent 30,000 Office Supplies 12,250 Insurance 3,900 Communication Expenses 2,800 Travel and Entertainment 2,650 Interest Paid 5,000 Repairs & Maintenance 7,250 Total Expenses 143,050 Net Profit 96,950 The statement is divided into three sections namely revenues, expenses, gains and losses.
Revenues are inflows financial assets into the company; it is generally sales gain from the services or product that the company provides. Expenses, on the other hand, are outflows like cost of selling, delivering, producing goods and services, or operating cost. When the company is a manufacturing enterprise, the cost of goods sold has to be determining to sales for the period. It is the sum of beginning inventory, net purchases, and all other buying, freight, and storage costs relating to the goods. It can be calculated by subtracting your ending inventory from your cost of goods available for sale.
Lastly, the statement would derive to the profit or loss. Advantages of income statement are that it shows profitability over a period of time, with revenue against its expenses. However, as not all transactions are in cash term, it is based on accrual accounting. Cash position is not reflected according. Brand recognition and loyalty are not captured in it. Cash Flow Statement (CFS) is a statement that shows cash or equivalents and where its cash inflow and outflow of the company’s account. Unlike the previous two statements, CFS shows cash transaction and position between period of time, not sales or purchases on credit.
It is constructed by three components, namely: cash flow on operating activities, investing activities, and financing activities. Operating activities is the cash component that is generated from the sales of the company’s goods or products effecting the core business operation. From purchase of raw materials, production cost, advertising cost and delivery to customers. The cash from operating activities is always compared to the company's net income; it adjusts according to the differences in revenue, expenses and credit transactions.
As not all transactions involve actual cash, many items are re-evaluated when calculating cash flow from operations. For instances, when the company purchase inventories by cash, the cash flows statement decrease while the current assets in balance increases. However, when the company purchases inventories on credit, there would be no adjustment in the cash flow statement. Hence, increase in accounts payable in balance sheet would be carried forward to the next financial period Adjustments for depreciation expense and for the gains and losses on the sale of long-term assets are included in this section too.
Investing activities are straight forward items that reports adjustments in the balances of fixed assets accounts like equipment, building and land, vehicles etc. Outflow and inflow of cash are normally meant for acquisition and divests of fixed assets. Financing activities are cash adjustment of fixed liabilities and owner' equity. Cash increases when the company takes up a loan or raised capital, when dividends are paid out, cash decrease accordingly. The following is a simple example of a cash flow statement, GHI Company Statement of Cash Flows for the month ended Dec 31, 2009