No matter what kind of business you work for after accounting training, you can rest assured that the three main financial statements will be of great importance to your employer.
From small start-ups to multi-national companies—they all need detailed information about financial performance and future prospects in order to make smart business decisions.
This data is prepared and delivered by the accounting team, using the three main financial statements: Balance Sheet, Income Statement, and Cash Flow Statement.
How are these documents structured and what do they reveal? Why are they so important? Let's look at each statement and break down the key elements accounting students should know.
Income Statement: The one most owners look at first
Although all three statements are required to form a complete picture of a company's financial position, many owners want to see the income statement first.
Why? Because the income statement shows whether a business is turning a profit. It's usually prepared every three months, and at the end of the fiscal year. Company management will look at this statement for a snapshot of revenues, expenses, gains and losses—culminating in the all-important "bottom line".
The bottom line is the company's net income (or net loss) and is listed at the end of the document. Basically, it's a calculation of revenue minus expenses. If that number is positive, it's good news for the businesses, any shareholders, and potential lenders.
If it's negative, it shows the company is not operating profitably—bad news for management, employees, investors, and other stakeholders.
But the income statement is really only part of the story of how a company is performing. Your future boss will need to see the balance sheet to learn what the business is actually worth.
Balance Sheet: The Business's Net Worth
The balance sheet does exactly what its name suggests: it shows the "balance" of income and expenditures over a given period of time, by listing assets, liabilities, and ownership equity. In simple terms, it shows what a company owns—and what it owes. It reveals the net worth of the business.
The balance sheet mimics the equation, Assets = Liabilities + Equity (a key concept taught in any accounting program). The document is usually organized into two columns: one side lists assets, the other lists liabilities.
Assets may include liquid assets (which can be quickly converted into cash) and non-liquid assets, like land, buildings, and equipment.
Liabilities will include accounts payable, employee wages, rent, loans, sales tax charged on purchases and anything else the business owes. At the bottom of the balance sheet, you'll find the sum of all the assets, as well as the total dollar amount of all liabilities and equity. These two numbers should be the same, or in other words, balanced.
Cash Flow Statement: Where is all the money going?
In simple terms, the cash flow statement documents how cash is flowing into and out of a business—where it's coming from, and where it's going.
This document seeks to answer questions like, "Is the company generating more cash than it's using?" (good!) and "Why is reported net income not turning into cash?" (red flag).
To figure out a company's "cash position", the accounting team will track all the cash coming in from operations (sales of goods or services) and external investments. They will also track cash flowing out to pay for business activities and expenditures (purchase of an asset, for example). Thirdly, the cash flow statement will list financing activities, such as money borrowed, or dividends paid to shareholders.
The cash flow statement is crucial, particularly for small businesses, for whom a shortage of cash can mean a quick slide toward bankruptcy. It's key for companies to keep a close watch on where they're spending money, how they're generating cash, and how much cash they have access to at any given moment.
So you can see that, looked at separately, each of the three main financial statements offers valuable data on a company's financial position. However, they must be viewed together to gain a complete picture of profitability, sustainability, and overall financial health.
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