Financial Statements

Financial reporting is a requirement of the U.S. Securities and Exchange Commission. The Financial Accounting Standards Board establishes the standards for financial reporting. Financial reporting is done via financial statements. This paper is intended to give the reader an understanding of the audience, purpose and nature of financial statements as well as an understanding of the use of financial accounting information in making informed and ethical business decisions. After reading this paper, the reader should be able to (a) define a financial statement, (b) define the audience, purpose and nature of financial statements, (c) describe the four types of financial statements, and (d) explain how financial accounting is useful for making business decisions.

Audience / Purpose of Financial Statements

A financial statement is a “report containing financial information about an organization” (Answers Corporation, 2007). Financial statements are essential pieces of information for business managers, suppliers, bankers, investors, buyers, sellers, and owners. Financial statements give information about the company that is important for decision makers, particularly the owners. Owners use financial statements to analyze company wealth.

More specifically, the purpose of financial statements, including accompanying notes, is to provide information about:

a. The amount and nature of an organization's assets, liabilities, and net assets, b. The effects of transactions and other events and circumstances that change the amount and nature of net assets, c. The amount and kinds of inflows and outflows of economic resources during a period and

the relation between the inflows and outflows, d. How an organization obtains and spends cash, its borrowing and repayment of borrowing,

and other factors that may affect its liquidity, and e. The service efforts of an organization (Financial Accounting Standards Board, 1993).

There are four main financial reports that companies use: (1) the balance sheet, (2) the income statement, (3) the cash flow statement, and (4) the retained earnings statement. The balance sheet records information on a company’s liabilities, assets, and net equity during a given period of time. The balance sheet can be used to manage the company inventory more efficiently. The income statement, “also referred to as the profit or loss statement, reports on a company’s results of operations over a period of time” (Answers Corporation, 2007). This can be used to measure how well a company buys and sells inventory.

The third financial statement is the cash flow statement, which reports a company’s cash flow activities, namely its operating, investing and financing activities. The cash flow statement serves four purposes:

(1) To use information about the past sources of cash to predict the company’s ability to generate positive cash flows in the future, (2) The establish the company’s ability to pay its bills and meet its obligations, (3) to ascertain whether the business’ cash is coming from operations mostly or from other sources instead, and (4) To understand the effect of investment and financing activities on the operation of the business (University of Delaware, 2006).

The retained earnings statement records a company’s portion of net income that is retained by the corporation, rather than distributed to its owners. The statement of retained earnings is a part of the balance sheet. “The retained earnings account on the balance sheet is said to represent an "accumulation of earnings" since net profits and losses are added/subtracted from the account from period to period” (Accounting School, 2007)

Nature of Financial Statements

Financial statements are written reports of data in accounting terms about a company that are considered to be fair and precise. Financial statements report characteristics of the business that are pertinent for investors, creditors and decision makers.

Use of Financial Accounting