Firms always need to understand how they are performing financially. It is for this reason that they maintain records of financial transactions. These records are then used to develop a profile of the performance. The profile is painted in financial statements. There are four basic types of financial statements with each serving a particular purpose. Income statement and balance sheet are among the financial statements (Peterson & Fabozzi, 2012). Statement of retained earnings and statement of cash flows are the other statements that offer insights into the financial health of a firm. In this paper, a look at these statements is offered and the functions that they serve for internal and external stakeholders are examined.
Statements and their purposes
The four basic financial statements have already been identified above. Each of these statements serves particular important functions. The income statement is used to show how much revenue, profits, losses and expenses have been reported during a particular accounting period (Peterson & Fabozzi, 2012). The income statement is regarded as the most crucial. This is because it offers insights regarding the routine operations of a firm. The main purpose of the balance sheet is to offer information regarding the assets, equity and liabilities of a business entity (Peterson & Fabozzi, 2012). With this information, it is possible to determine how solid an organization is. For a business to run properly, the total value of its assets should equal the sum of liabilities and equity. The balance sheet allows one to understand the capitalization of an organization. This financial statement also offers insights into the liquidity of a firm.
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Statement of cash flows and statement of retained earnings are the other basic financial statements. The primary purpose of the statement of cash flows is to show how much cash a business received and how much cash was paid out (Peterson & Fabozzi, 2012). The statement of cash flows is often used to determine the accuracy of such other financial statements as the income statement. For instance, when the statement cash flow shows that the business received more cash than it paid out but the income statement shows that the business suffered a loss, the income statement may be reexamined to ensure that it is indeed accurate. The statement of cash flows is usually given to third parties who wish to understand how well a company is performing. The statement of retained earnings is used to reflect any changes that have occurred in the equity amount during a certain accounting period (Peterson & Fabozzi, 2012). This statement is not as crucial as others and companies usually provide it as part of the financial statements that have been audited.
Types of accounts in the statements
The different financial statements discussed above contain certain relevant accounts. The number and nature of specific accounts that are included in these statements is determined by the type of business that an organization engages in. However, there are some basic and standard accounts that are found in the statements of nearly all businesses. The main accounts that are found in the income statement include revenues and expenses (Sinha, 2012). These accounts can be more specific. For instance, a firm can have accounts for such expenses as salaries and maintenance. Assets, equity and liabilities are the primary accounts found in the balance sheet (Sinha, 2012). As is the case with the accounts in the income statement, these accounts can be more specific. For instance, the general assets account can be composed of such smaller accounts as cash, petty cash, supplies, inventory and prepaid insurance, among many others. The statement of retained earnings is also made up of certain accounts. As has already been suggested in the discussion above, the specific account types are determined by the nature of business activities carried out by a firm. Net income and dividends are some of the accounts that can be found in a typical statement of retained earnings (Sinha, 2012). The statement of cash flows is typically composed of an account that details that cash flow from routine operations, an account with information on cash flow from investments and another that shows the cash involved in financing. These accounts are rather broad and a business may choose to create smaller accounts for recording particular transactions.
Importance of statements to internal users
Internal stakeholders such as employees and managers are among the individuals who rely on financial statements. One of the important functions that these stakeholders use the statements for is to understand how the business is performing (“Use and Users”, n.d). For example, the managers can use the income statement to understand if the business is making profit. The employees can also use the financial statements to determine how profitable and stable the company is. This determination allows the employees to establish if the company is able to meet all its obligations and ensure that they are paid in good time. The internal stakeholders also rely on the financial statements for making decisions (“Use and Users”, n.d). For example, the balance sheet can offer the managers with insights that allow them to decide if there is need to purchase more stock.
Importance to external users
Internal parties are not the only users of the financial statements. External stakeholders such as creditors, the government, investors and suppliers are among those who would find financial statements useful. The financial statements allow these parties to determine the financial strength of an organization so that they are able to make informed decisions (“Use and Users”, n.d). For example, investors may examine the company’s balance sheet and income statement to determine financial stability. They are then able to establish if the company is sufficiently stable to justify more investment. Lenders also rely on the financial statements to assess a company’s stability. The level of stability allows the lenders to determine if the company is able to honor its debt obligations. Suppliers would also find the financial statements useful because these statements enable them to determine if a company is able to pay for supplies (“Use and Users”, n.d).
The government and the general public are the other external parties who rely on the financial statements. The government uses these statements to determine how much tax a company is required to remit (“Use and Users”, n.d). The income statement allows the government to levy taxes on the profits that the company has made. The financial statements also allow the government to perform its regulatory role. For instance, an insurance company is required to hold certain amounts in reserve for meeting future claims. It is the mandate of the government to ensure that the reserves are indeed sufficient to meet these claims. The government may also examine a company’s financial statements to examine its growth and to identify if there are any opportunities for growth. The general public would also find financial statements to be useful (“Use and Users”, n.d). For instance, by examining these statements, the members of the public are able to make decisions regarding investing in the stock of a firm that is public traded.
In conclusion, that financial statements serve important purposes is not in question. Balance sheets, income statements, statement of retained earnings and statement of cash flows all shed light on the performance of an organization. These statements contain different accounts whose nature and specific contents depend on the affairs that an organization engages in. The statements of account are useful for different parties. Internal stakeholders rely on them to understand how the company is performing. External parties also use these statements to determine the stability of a firm. Given the important roles of these statements, it is important to ensure that they are accurate.
References
Peterson, P. P. & Fabozzi, F. J. (2012). Analysis of Financial Statements. Hoboken, NJ: John Wiley & Sons.
Sinha, G. (2012). Financial Statements Analysis. New Delhi: PHI Learning Pvt. Ltd. Use and Users of Financial Statements. (n.d). Retrieved 21 st May 2017 from
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