Elements of Financial Statements

Though it is said organizations have an indefinite life, in reality they do have a particular life cycle. These are birth, growth, plateau and finally no growth or decline. This is not unlike a product life cycle. In periods of slow growth, product extensions are introduced to increase its life span. Similarly, companies need to make changes, adapt to new technologies and economic scenarios to survive and earn profits. Some companies are bought over, and while their names stay, the businesses change dramatically.

So corporations that have lasted a long time (e.g. Coke, IBM, Unilever, and Microsoft) have perfected to a great degree to adapt rapidly to changes in the marketplace and stay ahead in the game. Apple is an excellent example of a company that reinvented itself, introduced a slew of new products that redefined the market. It is easy for companies to get complacent and be immune to changes in the industry. Companies need to reassess their processes from time to time to stay efficient and increases profitability.

Financial reports play an important role in helping monitor an organization’s health, attract investors and keep stakeholders. The information needs to be accurate and relevant. Consistent practices tend to lead to accurate reports which are useful and relevant to the user. Regular cycles of these processes lead to capturing of accurate information, say, a weekly analysis of financial reports.

Financial Statements

The four key financial statements are:

  1. The Income Statement
  2. The Statement of Owner's Equity
  3. The Balance Sheet
  4. Statement of Cash Flow

Financial statements are documents that concisely communicate the monetary situation of a business. Different statements describe different areas of the business's financial situation.

The income statement describes how much profit a business earns over a period of time. This document shows the amounts for revenue, expenses, and net income or net loss.

The statement of owner’s equity describes all changes in owner's equity over a period of time. This document shows the amounts for owner's investments, owner's withdrawals, net income, and net loss.

The balance sheet describes the financial situation of a business at a given time. This document shows the assets, liabilities and owner's equity.

The statement of cash flow describes the amount of cash going in and out of the business over a period of time. This document shows the movement of cash in operating, investing, and financing activities.

Financial statements are important as communication tools. They report on a business's financial situation from different perspectives. Many people depend on these reports, such as banks, partners, investors, suppliers, managers, customers, shareholders, and board of directors.

To understand these financial statements we will take the financial statements of Innovative Products, Inc., a fictitious company that is into the business of manufacturing innovative home products.