Business financial statements and analysis

Business Financial Statements

Most theoretical sources acknowledge the fact that the four basic financial statements are the balance sheet, the income statement, the cash flow statement and the statement of stockholders' equity. We will be briefly referring to each in part and then will emphasize the interrelations between them.

The balance sheet presents the asset value and the main components of the total asset value, as well as the source of finance for these assets. In this sense, the total asset value will equal the total liability value. The balance sheet is in many ways the financial statement that tells us most about the overall situation of the company at a certain date, a snapshot considered as the most complete source of information on the company's financial situation.

The cash flow statement is "a summary of a company's cash flow over a period of time," which means that it covers the payments and the cash receipts that a company is handling over a certain period of time. This is a more detailed overview on the company's liquidities which were covered in the balance sheet. The cash flow statement allows the management to make decisions related to the company's sales or payments by analyzing the more detailed cash flow.

The income statement shows "a summary of the flow of transactions the business has had over the entire accounting period." Theoretically speaking, each business will have certain sales revenues, but also expenses implied by those sales, including operating or interest expenses. The income statement allows one to analyze what the expense proportion from total sales revenues or what the net income is.

As the name points out, the statement of stockholders' equity shows "the gap between the amount of equity the owners have in the business at the beginning of the accounting period and the amount of their equity at the end of the period." This means that such a statement allows the manager to see any possible changes that may have occurred to the owners' rights over the business.

I have made this brief presentation of each of the four basic types of statements in order to point out what role each plays. We may now turn to the interrelationships between them.

First of all, we should take a look at some of the basics relationships and see how some of the figures and entries from one statement are used in another. The net revenues and the total sales expenses of a company are listed in the company's income statement. Subtracting one from the other will give the company's net sales income. Listed in the company's income statement, this is also added to the beginning balance of owner's capital in the statement of stockholders' equity. Indeed, we have the retained earnings entry in the statement of stockholders' equity and, subsequently, the add investments or net income fields.

At the end of the financial period that is being analyzed, we have the retained earnings entry. The value entered in this field is also used further on in the balance sheet, as we have there the owner's equity field.

So, this brief example shows how the balance sheet, income statement and statement of stockholders' equity are related one to another. The logic is quite simple if we follow the theoretical explanations presented in the beginning of the essay. The net income that appears in the income statement is itself nothing but an increase in the owners' wealth, as an increase to the company's overall value. In this sense, it seems natural to find it in the statement of stockholders' equity, as an increase to their interest in the company. Further more, the owners' equity appears in the balance sheet as a partial liability, as funds that the company has invested in the total asset value.

I have mentioned previously that the cash flows statement is an extension of the balance sheet, in the sense that it gives a more detailed overview of the liquidity situation in the company. Indeed, the cash position in the balance sheet at the end of the period that is being analyzed is also shown on the statement of cash flows, as "cash at the end of the period."

Of course, the relationship between the statement of cash flows and the balance sheet is much deeper than this. In order to refer to this, we need to mention that the cash flow statement for the year generally reflects three different cash flow positions or categories: cash flows from operating activities, cash flows from investing activities and cash flows from financing activities. I have discussed the interrelationship between the cash flow from operating activities and the balance sheet. The other two categories are also reflected in the balance sheet.

Indeed, the company may invest during the financial year in fixed assets, such as property or equipment. The negative difference reflected on the statement of cash flows will be noted as an increase in the total asset value on the balance sheet, that is, an increase in the value for "property, plant and equipment."

This is the same for the cash flows from financing activities, which are strictly connected to the "liabilities and owners' equity" fields on the balance sheet. The financing activities refer to such things as borrowing or stock issues during the financial year. The "long-term debt borrowing" value will be noted as an increase in the "long-term notes payable" value on the balance sheet.

As a general conclusion here, we may assert that the balance sheet is generally the statement where the other three statements, with an accent on the income statement and the statement of cash flows, find their values recorded. In this sense, we may assert that the income statement and the statement of cash flows form separate and more comprehensive explanations of several positions in the balance sheet.

In my opinion, this is not the only way that the interrelationship between the four basic financial statements can be demonstrated. Managers often use comparative tools and forms of analysis, because the figures in the balance sheet or the cash flow statement will not tell you much if they are not included into a more detailed analysis. This is where the financial ratios fit in the picture.

The financial ratios use values from the four basic financial statements in order to give out evaluations on the company's profitability or liquidity. There are generally six types of major financial ratios: liquidity ratios, debt management ratios, asset management ratios, profitability ratios, growth ratios and market value ratios.