All corporations have a story. The story includes a scheme (their strategy), a battle (their competition), and a development atmosphere (their operations that execute the strategy). A firm tells its story in financial terms via its financial accounting reports which is basically prepared by its team of accountants.
Accountants are communicators, and accounting is the art of communicating financial information about a business entity to users such as shareholders and managers. The communication is usually in the form of financial statements that show in money terms the economic resources under the control of the management.
It is an art to understand the financial information that companies publish in financial reports and understand the economic impact of the main accounting policies. This art lies in selecting the information that the user finds understandable, relevant, reliable, and comparable.
It is of utmost importance to emphasize that to interpret financial statements, one needs to understand how they have been prepared. In this short piece, I shall take us through the basic financial statements and what differentiate one from another.
Types of financial statements
There are four plus one (4+1) accounting statements, these are:
- Statement of financial position (IFRS name). It is also known as the Balance Sheet. The balance sheet records the basic accounting equation of assets = liabilities + equity, at a certain point in time. It reveals the financial health of the business at a point in time.
- Statement of comprehensive income (IFRS name). It is also known as Income Statement. It should be noted that this financial statement records all revenues and expenses for a business during a specific time period. It provides essential information for business owners. You can create an income statement on a monthly, quarterly, or annual basis.
- Statement of cash flows (IFRS name). This is also known as cash flow statement (CFS), it is a financial statement that summarizes the movement of cash and cash equivalents (CCE) that come in and go out of a company. The CFS measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses. It is worth noting that as one of the three main financial statement, the CFS complements the balance sheet and the income statement.
- Statement of changes in equity (shareholders equity). This is also known as statement of retained earnings. This is a business’ financial statement that measures the changes in owners’ equity throughout a specific accounting period. It covers the net profit or loss and dividend payments.
- Notes to the financial statements (IFRS name). Notes to financial statements have something to do with all the four principal financial statements. It actually discloses the detailed assumptions made by accountants when preparing a company’s income statement, balance sheet, statement of changes of financial position and statement of retained earnings. The notes are very essential so as to fully understand the various financial statement documents.
In our next discussion on corporate financial accounting, we shall endeavor to look at the basic accounting equation, as a way of understanding how to interpret the financial statements. In looking at the afore mentioned, we shall be learning about the key accounts that make up all these financial statements and how to apply them given a basic accounting problem to solve. These key accounts are assets, liability, owners’ equity, revenue, and expenses.
Notes: IFRS is International financial reporting standards.