Financial Position

Financial Statements

Using the elements of and understanding the purpose of the balance sheet and other financial statements assist managers in making effective business decisions. This module explains how to use the balance sheet and income statement, also known as a profit and loss statement, to describe the financial position of an organization. Understanding the specific elements of both financial statements helps managers understand how different areas of a business affect the financial performance of a company. Each financial statement communicates different financial information about the company. Communication begins with the title of each financial statement. The title of each statement identifies the company whose financial information is being communicated, which financial statement the user is reading, and the date or period the statement covers.

Users of Financial Statements

There are two categories of users of accounting information. The categories are internal users and external users. Internal users include managers, supervisors, employees of the company, and company officers. Internal users need accounting information to plan, organize, and finance a business. External users include investors, creditors, vendors, suppliers, bankers, labor unions, taxing authorities, and regulatory agencies. These users need financial information because they are interested in the financial condition of a business. For example, if credit is extended to the company, will the company be able to repay the debt? If the labor union asks for an increase in benefits, will the company’s profit cover these costs? If the company wants to expand operations, can management generate funds from external sources such as investors, bankers, or shareholders?

Income Statement

The income statement communicates the results from operations for a specific time period. The income statement communicates the revenue earned and costs and expenses incurred. This information is important because the user of this information (internal or external) will know if the company is making money (net income or net profit) or losing money (net loss). When a reader looks at this statement, they expect to see the various types of revenue that a company earns, such as the amount from selling products or the amount of fees earned from providing services. The reader also expects to see the various costs and expenses incurred that are subtracted from total revenues to determine net income or net loss. The formula for this calculation is:

Total Revenues – Total Cost and Expenses = Net Income or Net Loss.

Decision makers of any company are interested if revenues are exceeding expenses or if expenses are exceeding revenues. Having this information will impact the decisions they make and their plans or strategies for the future. Managers need to increase revenues and reduce costs if the company wants to survive long-term in business.

Balance Sheet

The balance sheet is the financial statement that communicates the financial position of a business at a specific date or on a specific date. A user is expecting to see the balances of the assets, liabilities, and equity accounts. All external and internal users of this statement will prepare various ratios regarding the liquidity or the ability to pay debt of a company. Bankers and creditors are interested if this company can repay short-term or long-term debt. Internal users are concerned about a company’s ability to pay back debt too. Internal users are also interested in the company’s bank balance, level of inventories, outstanding receivables, and other current assets. Carrying excess inventory increases costs. A growing accounts receivable balance can cause internal cash flow problems. Managers need to ensure inventory levels are appropriate but not excessive, and that enough cash is in the bank to cover current liabilities.

The income statement and balance sheet are two important financial statements that communicate information to both internal and external users. A company succeeds because of proactive actions. Failure to properly monitor the changes in values contained on these financial statements year over year will result in a failure to identify potential warning signs of financial trouble. This will result in a company taking reactive actions, often after irreversible damage has been done.

USERS OF FINANCIAL STATEMENTS 

There are two categories of users of accounting information: internal and external. Internal users include managers, supervisors, employees of the company, and company officers. Internal users need accounting information to plan, organize, and finance a business. External users include investors, creditors, vendors, suppliers, bankers, labor unions, taxing authorities, and regulatory agencies. These users need financial information because they are interested in the financial condition of a business. 

Financial Statements

INCOME STATEMENT 

The income statement communicates the results from operations for a specific period, the revenue earned, and costs and expenses incurred. This information is important because the user of this information will know if the company is making money or losing money. The formula for this calculation is: 

Total Revenues – Total Cost and Expenses = Net Income or Net Loss. 

Decision makers of any company are interested if revenues are exceeding expenses or if expenses are exceeding revenues. Having this information will impact the decisions they make and their plans or strategies for the future. 

Income Statement

BALANCE SHEET 

The balance sheet is the financial statement that communicates the financial position of a business at a specific date or on a specific date. A user is expecting to see the balances of the assets, liabilities, and equity accounts. All external and internal users of this statement will prepare various ratios regarding the liquidity or the ability to pay debt of a company. 

The income statement and balance sheet are two important financial statements that communicate information to both internal and external users. 

Balance Sheet
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