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An effective guide to understanding financial statements

An effective guide to understanding financial statements 

Management of any business requires a flow of information to make informed, intelligent decisions affecting the success or failure of its operations. Investors need statements to analyze investment potential. Banks require financial statements to decide whether or not to loan money, and many companies need statements to ascertain the risk involved in doing business with their customers and suppliers.

Financial statements tell the story of your business and your future fortunes.

It can be tough for business owners to find or make the time to read financial statements – the income statement, the balance sheet and the statement of cash flows. In addition to other seemingly more urgent demands on your time, obstacles can include the fact that many highly intelligent business owners may have little training or experience in interpreting numbers from a financial statement, so they may not understand them or understand their importance.

There are four main financial statements. They are:

  • Balance sheets

The balance sheet is a snapshot at a single point in time of the company's accounts – covering its assets, liabilities and shareholders' equity. The purpose of the balance sheet is to give users an idea of the company's financial position along with displaying what the company owns and owes.

  • Income statements

The Income statement is used by management within the company, but also by investors and creditors outside the company to evaluate profitability, performance and aid in the assessment of risk for the investor or creditor. The Income Statement is divided into three parts: Total revenues, total expenses, and net income.

  • Cash flow statements

The cash flow statement is the financial statement that presents the cash inflows and outflows of a business during a given period of time. It is equally as important as the income statement and balance sheet for cash flow analysis. Without a cash flow statement, it may be difficult to have an accurate picture of a company’s performance. The income statement will tell you how much interest you paid on a loan and the balance sheet will tell you how much you owe, but only the cash flow statement will tell you how much cash was consumed servicing that loan. The income statement will record sales and profits but it’s the cash flow statement that will alert you if those sales aren’t generating enough cash to cover expenses.

  • Statements of shareholders’ equity

Stockholder's equity on a financial statement, such as a balance sheet or a statement of retained earnings, indicates to an investor or a regulator the owners' investments in a corporation. Stockholder's equity on a financial statement may be computed at a given point in time, such as the end of the year or quarter.

Need accounting training? Why not read about finance training and find out more about the financial accounting courses we offer at London TFE.