The four basic financial statements are: the Balance Sheet, the Income Statement, the Statement of Retained Earnings and the Statement of Cash Flows (the names of the statements are capitalized). These statements, along with additional data and analysis, are included in annual reports filed by public companies. We'll examine these statements briefly; prospective accountants should encounter and master these statements early in their accounting education.
The Balance Sheet
The Balance Sheet is a snapshot of a company's financial position at a given point in time. It is comprised of three parts: assets, liabilities and equity.
- Assets are the economic resources of a company. They are tangible resources a company uses to operate its business and include Cash, Inventory and Equipment (accounts in financial statements are capitalized).
- Liabilities are the company's debts. Liabilities are the claim that creditors have on a company's resources.
- Equity is the net worth of a company. It represents the claims a company's shareholders have on its resources.
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Media Entertainment, Inc Balance Sheet (December 31, 2005) _________________________________________________________________________________________________________ |
|
|---|---|
| Assets Cash 203,000 Accounts Receivable 26,000 Building 19,000 Total Assets 248,000 | Liabilities Accounts Payable 7,000 Equity Common Stock 10,000 Retained Earnings 231,000 Total Liabilities & Equity 248,000 |
The Income Statement
The Income Statement represents the results of a company's business over a specific time period (e.g., one year, one quarter, etc.) and includes Revenues, Expenses and Net Income.
- Revenue is the income that results from a company's sale of its goods or services and is recorded when it is earned.
- Expenses are the costs incurred by a company in a given time period to generate the revenues earned during that same period of time.
- Net Income is the difference between revenues and expenses.
For example, in order for a manufacturer to produce a product it must buy the materials necessary to make that product and pay the people who make and sell that product. Recording the revenue and expenses in the proper time period is a key accounting principle; abusing or ignoring this principle has landed many companies in hot water. Some companies have been known to sign a contract for a sale that won't take place for some time (months or even years in the future). Companies looking to "cook the books" (misleadingly manipulate the numbers), will try to find creative ways to record that revenue for the current quarter or fiscal year in order to make current results and, by extension, the company's operations and management, look artificially good. This practice can be dangerous. For one thing, the company often doesn't collect any money until the actual transaction takes place. Based on the fudged numbers, a company's shareholders, creditors and suppliers may think the firm has more cash than it actually does, which can prove disastrous if a company has to make a payment. Additionally, sales booked in advance can be canceled, meaning the company will never collect the revenue it already reported.
This is how a basic Income Statement looks:
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Media Entertainment, Inc Income Statement (For the year ended December 31, 2005) _________________________________________________________________________________________________________ |
||
|---|---|---|
| Revenues Services Billed | 100,000 |
|
| Expenses Salaries and Wages Rent Expense Utilities Expense | (33,000) (17,000) (7,000) | (57,000) |
| _____________________________________________________________________________________________________________________ | ||
| Net Income | 43,000 | |
The Statement of Retained Earnings
The Statement of Retained Earnings is a reconciliation of the Retained Earnings account from the beginning of the year. When a company announces income or declares dividends, this information is reflected in the Statement of Retained Earnings. Net income increases the Retained Earnings account. Net losses and dividend payments decrease Retained Earnings. The Statement of Retained Earnings doesn't provide any information that isn't available in other financial statements. It's meant to be a quick analysis of what management is doing with a company's earnings.
This is a sample Statement of Retained Earnings:
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Media Entertainment, Inc Statement of Retained Earnings (For the year ended December 31, 2005) _________________________________________________________________________________________________________ |
|
|---|---|
| Retained Earnings, January 1, 2005 | $200,000 |
| Plus: Net income for the year | 43,000 |
| ___________________ | |
| 243,000 | |
| Less: Dividends declared | (12,000) |
| Retained Earnings, December 31, 2005 | $ 231,000 |
The Statement of Cash Flows
The Statement of Cash Flows presents a detailed picture of all cash inflows and outflows during a given period. It's divided into three categories.
- Cash flows from operating activities includes the cash effects from transactions involved in calculating net income.
- Cash flows from investing activities is cash from non-operating activities. This involves items classified as assets on the Balance Sheet, such as the purchase or sale of equipment or investments.
- Cash flows from financing activities includes items identified as liabilities and equity on the Balance Sheet, such as the payment of dividends or paying off debts.
This is the basic format of a Statement of Cash Flows:
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Media Entertainment, Inc Statement of Cash Flows (For the year ended December 31, 2005) _________________________________________________________________________________________________________ |
||
|---|---|---|
| Cash flows provided from operating activities | ||
| Net Income | 33,000 | |
| Depreciation Expense | 10,000 | |
| Increase in Accounts Receivable | (26,000) | |
| Increase in Accounts Payable | 7,000 | (19,000) |
| __________ | ____________ | |
| Net cash provided by operating activities | 24,000 | |
| ____________ | ||
| Cash flows provided from investing activities | ||
| Purchase of Building | (19,000) | |
| Sale of Long-Term Investment | 35,000 | |
| ____________ | ||
| Net cash provided by investing activities | 16,000 | |
| ____________ | ||
| Cash flows provided from financing activities | ||
| Payment of Dividends | (12,000) | |
| Issuance of Common Stock | 10,000 | |
| ____________ | ||
| Net cash provided by financing activities | (2,000) | |
| ____________ | ||
| Net increase (decrease) in cash | 38,000 | |
| Cash at the beginning of the year | 165,000 | |
| ____________ | ||
| Cash at the end of the year | 203,000 |