Today I like to rehash the most popular topic under Corporate Financial Accounting, discussing their interrelatedness.
The four principal financial statements are:
Statement of Financial Position, SOFP – This is also called The Balance Sheet; It showcases the relationship between the Asset (A), Liability (L), and Owners’ Equity (OE) of an entity at the close of a particular day, i.e., A=L+OE.
SOFP gives a holistic financial view of the entity. Investors and financiers use information from here to decide on investing (or not) and lending to the organization (or not) respectively.
The information from SOFP may be used to prepare the other financial statements, for example, the earned capital and contributed capital detailed under OE are the major compositions of the Statement of Changes in Equity. Inventory accounts payable, property, plants, and equipment under assets are major components of the operating and investing activities respectively for the Cash Flow Statement.
From the share recapitalization of Union Bank in December 2010, which resulted from retained losses because of the sub-optimal balance sheet, I have learned to critically review the SOFP while reviewing and appraising credit requests, as these forms the basis of decisions to either lend to an entity or not.
Statement of Profit or Loss and Other Comprehensive Income – commonly called Income Statement; it summarizes activities that produced revenue during the review period, i.e., Total Revenue -Total Spending (Expenses) = Net Profit (or Loss).
The result here (either profit or loss) is recorded in the Statement of Changes in Owners’ Equity as retained earnings or earned capital. Net Profit or loss is the starting point in preparing the Statement of Cash Flows using the indirect method.
Statement of Cash Flows –This showcases the sources of cash received into the entity’s books within the period and how they were utilized. A Cash flow Statement is prepared by taking into cognizance accounts from the SOFP and the Statement of Profit or Loss. There are three parts to the Cash Flow Statements: the Operating, Investing, and Financing activities.
Projected Cash Flow Statements for proposed facility tenor is one of the items required to analyze the viability of a loan during credit appraisals and approval processes by a bank, and our classroom discussion of the Dec. 2007 cash flow statement for E-Tranzact International’s case study has helped my understanding of this financial statement. I now easily relate to customers’ thoughts on their cash flow projections.
Statement of Changes in Owners’ Equity shows the transactions that affect the owners’ contributed capital, examples of this is the amount that the business owners apportion to themselves from the net incomes (or loss).
Notes to the Financial Statements is the “plus one” and it is crucial as the four statements because it gives in-depth information on the four financial statements. Financial statements are usually incomplete without the Notes to the Financials.
I have found accounting quite interesting so far in my MBA journey, and I believe this is just the beginning.