06/02/2023 in Accountant

Using the Four Major Financial Statements to Gauge Current Performance and Drive Future Results

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Accounting standards generally acknowledge four main types of financial reports: the balance sheet, the statement of changes in equity, the income statement (also known as the profit and loss statement), and the statement of cash flows. Each of these financial statements serves a specific purpose. Here is a brief summary of each:

Balance Sheet

The balance sheet offers a snapshot of the business’s financial condition. In simple terms, it presents what the business owns (cash, accounts receivable, inventory, fixed assets, and other assets) and what it owes (accounts payable, credit cards, lines of credit, loans, and other payables). The difference between the assets and liabilities is known as owner’s equity. By comparing and tracking these balances over time, the business owner can gauge the current strength of the financial condition and determine if it is trending positively or negatively.

Statement of Changes in Equity

In the early stages, it is not uncommon for a business’s equity to be negative, particularly when it relies heavily on debt financing. However, as the business gradually repays its debts, the equity eventually becomes positive. In a mature business with most debts paid off, the equity balance tends to stabilize. The statement of changes in owner’s equity monitors the accumulation or reduction of equity over a specified period, providing valuable insights into the business’s performance.

Income Statement

The income statement is a widely recognized financial statement that allows for a detailed analysis of how the business is performing. It tracks revenue and significant expenses, enabling the identification of trends that can enhance financial performance and cash flow. Additionally, the income from operations serves as an indicator of the business’s value.

Statement of Cash Flows

The success of a business hinges on its ability to generate cash from operations and responsibly allocate that cash towards reinvestment, debt payments, and returns to investors. The statement of cash flows provides insights into how cash enters and exits the business, serving as a valuable tool for projecting cash flows and identifying areas that need improvement.

Taken together, these four fundamental financial statements offer a comprehensive view of the business. Regular review of these statements equips management with the necessary insights to maximize profits and cash flow.