Financial statements (or financial reports)
- are formal records of the financial activities of a business, person, or other entity.
- are often referred to as accounts
- provide an overview of a business or person’s financial condition in both short and long term.
- all relevant financial information of a business enterprise, presented in a structured manner and in a form easy to understand.
Purposes of financial statements
- to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions
- owners and managers require financial statements to make important business decisions that affect its continued operation
- employees also need these reports in making collective bargaining agreements (CBA) with the management, in case of labor unions or for individuals in discussing their compensation, promotion, rankings.
- prospective investors make use of financial statements to assess the viability of investing in a business.
- banks and other lending institutions use them to decide whether to grant a company fresh working capital or extend debt securities to finance expansion and other significant expenditures.
Business enterprises are individuals or associations of individuals that control and use resources for a variety of purposes, specially that of yielding return to the enterprise owner (Daughtney 1981).
Basic Types of Financial Statements for a Business Enterprise
- Balance sheet, also referred to as statement of financial position or condition, reports on a company’s assets, liabilities, and ownership equity as of given point in time.
- Income statement, also referred to as Profit and Loss Statement (or a “P&L”), reports on a company’s income, expenses, and profits over a period of time.
- Statement of retained earnings explains the changes in a company’s retained earnings over the reporting time.
- Statement of cash flows reports on a company’s cash flow activities, particularly its operating, investing, and financing activities.
Business transactions are events or exchanges which affect the assets, liabilities or owner’s equity of an organization (Druker 1977)
Each transaction consists of debits and credits and for every transaction they must be equal.
For Every Transaction
Value of debits = Value of Credits
A + E = L + OE + R
A = Assets
E = Expenses
L = Liabilities
OE = Owner’s Equity
R = Revenues
Debit Accounts (A + E) = Credit Accounts (L + OE + R)
Debits are on the left and an increase in a debt account reduces a credit account. Credits are on the right and an increase in a credit account decreases a debit account.
- When you pay with cash, you increase rent (expense) by debiting and decrease cash (asset) by crediting.
- When you receive cash for a sale, you increase cash (asset) by debiting and increase sales (revenue) by crediting.
- When you buy equipment (asset) with cash, you increase equipment (asset) by debiting and decrease cash (asset) by crediting.
- When you borrow cash with a loan, you increase cash (asset) by debiting and increase loan (liability) by crediting.
Assets are economic resources acquired through a transaction or event that can provide economic utility in future production or revenues.
Assets are classified (Julian 1974) thus:
- Current assets are cash or other types of assets that can readily converted into cash. These assets are expected to consume or sold within one year or within the normal operating cycle.
Classification of current assets:
- Cash on hand are currency or cash items on hand. Includes checks, bank drafts, money orders, treasury warrants, etc.
- Cash in bank are deposits in a bank which can be withdrawn or used for current operations without any restrictions
- Accounts receivable are open accounts without any formal written promise to pay.
- Notes receivable are open accounts with any formal written promise to pay.
- Prepaid expenses are short term prepayments of current operating expenditures. Ex: prepaid rent, prepaid insurance, office supplies, and store supplies
2. Property, plant and equipment are long term or long-lived tangible assets with an estimated life of more than one year and re acquired for the purpose of using them in the business to generate revenues.
- Equipment - plant equipment, office equipment, store equipment, delivery or transport equipment
- Furniture & Fixtures
Liabilities are economic obligations resulting from past transactions or events which can be measured in monetary terms. They are settled through the performance of economic resources.
Classifications of Liabilities
- Current liabilities are obligations which must be liquidated by using current assets or the creation of other current liabilities within one year of normal operating cycle.
- Accounts payable refers to the indebtedness arises from purchase of goods & services, materials, supplies in an open charge business.
- Account payable non-trade are those that do not arise from purchase of merchandise, materials, supplies in the ordinary course of business
- Notes payable are short term obligations which are evidenced by promissory notes.
- Accrued liabilities are accumulated debts arising out of services rendered to the business enterprise before the balance sheet date but payable at later time.
- Unearned income includes revenues that are collected in advance but have not been earned.
2. Long term Liabilities are obligations which are not expected to require the use of current assets or the creation of current liabilities within one year operating cycle.