Understanding Financial Statements
Financial accounting’s focus is on the financial reports distributed to people outside of the company. The major component of financial reporting is the financial statements: income statement, balance sheet, statement of cash flows, and the statement of stockholders’ equity. The income statement indicates a company’s profitability during a specified time period such as one year, three months or one month.
Under accrual accounting the income statement reports the amount of revenues earned and the expenses that were incurred to earn the revenues. Expenses also include costs that expired during the period of the income statement. If a corporation’s stock is publicly traded, the income statement will also report the earnings per share of common stock. The balance sheet reports a corporation’s assets, liabilities, and stockholders’ equity as of a specific instant, such as midnight of December 31. Most balance sheets will group all of the current assets and all of the current liabilities. This allows readers to easily see the corporation’s working capital and current ratio. The statement of cash flows organizes the explanations of the change in cash and cash equivalents into three sections: operating activities, investment activities, and financing activities. The statement of stockholders equity provides a summary of the changes occurring to stockholders’ equity during the accounting period. The changes include net income, dividends declared, purchase of treasury stock, and other comprehensive income.
In order for the readers of these financial statements to make comparisons with other companies, it is necessary that the financial statements follow some common rules. The rules are referred to as generally accepted accounting principles or GAAP and consist of several components. One component of GAAP is the basic or fundamental accounting principles and concepts such as cost, matching, going concern, economic entity, materiality, conservatism, consistency, reliability, and others.
Lastly, GAAP includes industry practices. For example, the balance sheet of a public utility will list the plant assets ahead of its current assets. Unique reporting practices often occur in industries that are regulated by government agencies.
The financial accounting and financial reporting of publicly traded corporations also include the annual report to the Securities and Exchange Commission, the annual report to stockholders, and various press releases on financial matters.