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The Four Financial Statements

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The Four Financial Statements


1. THE BALANCE SHEET (aka - The Statement of Financial Condition)

2. THE INCOME STATEMENT (aka - The Profit & Loss [P & L] Statement)

3. THE STATEMENT OF RETAINED EARNINGS (aka - The Statement of Net Worth)


The first concept that one must understand is that all businesses must keep records of what goes on in the business for two very distinct and separate purposes. The first set of reports, called the financial statements, is basically a history of what has happened to the company in financial terms for a specified period of time. What I sometimes like to refer to as the financial road maps of corporate information, stress the importance of the types of information that they provide us. While these reports or statements are obviously invaluable to the company’s management, they are mainly used by external individuals and organizations, completely apart from the company. Such individuals and organizations might be stockholders and potential investors, the S.E.C., the I.R.S., banks or other lenders, and the company’s creditors. On the flip side of this are the reports that are used predominately by the company’s internal management personnel to appraise and assess the success, or lack thereof, of their actions in running the company thus far and to help them make decisions that will affect the future of the company. The information that I am referring to here is known as the financial ratios. These are also used by external analysts for many of the same purposes. In these Financial Management courses, there is an extensive discussion of both the financial statements and financial ratio analysis, because the numbers shown in the financial statements are only part of the corporate mosaic. These numbers tell a story and the only way to understand what it is all about, is to analyze each part. Part one is comprised of the four financial statements. These statements give us a broad landscape of the company and what is going on with it. Each statement is like a new chapter of the story.

It starts off with the Balance Sheet and that, once upon a time, or in financial terms, at one particular point in time, the company owned a bunch of stuff it used to operate the business called Assets. In order to buy those assets, the company’s management borrowed some money, known as the company’s Liabilities, because the funds invested by the owners of the business, called their Net Worth or Owners’ Equity, were not sufficient for all the needs of the business. Thinking about it logically, it is easy to see why the company’s Assets must always equal its Liabilities plus its Net Worth or Owners’ Equity on this Statement of Financial Position, also know as the Balance Sheet.

The next chapter is the Income Statement, often called the Statement of Profits and Losses, or just the P & L. The Income Statement simply tells us, in financial terms, how well we did over a specific period of time. It states how much revenue was earned by the firm, what it cost to procure that revenue, or the expenses for the period, and what, if any, profit was left at the end of this time frame.

Chapter Three is the Statement of Cash Flows and that gives us an idea of where our money was made or spent; whether it was in the operations of the business, obtaining or repaying financing for the business, and/or in conjunction with the various investment activities of the business. So basically, the Cash Flows Statement tells us how much cash we started with, where it came from and where it went, and again, what was left, our balance, at the end of that time frame or period.

While it may seem

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