Businesses typically prepare three principal financial statements to report the results of their activities.
1. The balance sheet
Also known as the statement of financial position, presents a snapshot of the resources of a company, (their assets) and the claims on those resources (liabilities and owner’s equity) at a particular moment in time.
Current assets and current liabilities, as mentioned in the finance section, are essentially relatively short-term use assets and liabilities. Current assets are reasonably expected to be converted into cash within one year in the normal course of business. These assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash.
Similarity, current liabilities are essentially short-term debts or obligations that are due within one year. Current liabilities appear on the company’s balance sheet and include short-term debt, accounts payable, accrued liabilities and other debts.
It is important for managers to pay attention to current assets and current liabilities, as they indicate the company’s ability to deal with short-term cash obligations.
Liquidity is the ability to pay short-term obligations when they fall due. It is often expressed as a radio.
The current radio measures whether or not a firm has enough resources to pay its current liabilities. It is expressed as follows:
The current radio is an indication of a firm’s market liquidity and ability to meet creditor’s demands.
The ideal current radio values vary from industry to industry. Usually, a current radio of 2:1 is considered acceptable. The higher the current radio is, the more capable the company is of paying its obligations.
The lower the radio is, the greater the likelihood that it may have problems paying its bills on time.
2. The Income Statement
The income statement, or “statement of profit and loss” (or P&L) in British English, documents a company’s revenues and expenses during a particular period of time.
It shows how revenues are transformed into net income (the result after all revenues and expenses have been accounted for, also known as “net profit” or the “bottom line“).
This statement shows the costs associated with generating revenues, in addition to costs and expenses, including depreciation and amortization. It helps managers and investors see whether the company made or lost money during the period being reported.
Unlike the balance sheet, which represents the company’s financial position at a particular moment in time, the income statement reports performance over a particular period, typically a quarter or a fiscal year.
3. The Statement of Cash Flows
Also known as the “Cash Flow Statement”, this is an important financial statement that indicates how changes in the balance sheet and income statement affect the amount of cash equivalents.
Cash and other liquid assets are extremely important to business and are essential for businesses to meet their short-term financial obligations.
– Cash flow problems –
Managing cash flow and avoiding cash flow problems is extremely important, as poor cash flows is a very common reason for the failure of small businesses.
– The Annual Report –
The annual report is a larger document sent to all owners and parties interested in the company. A complete annual report includes the balance sheet, income statement and statement of cash flows for a company for a given period. It may also include a statement of retained earnings, notes to the financial statements and additional supporting documents.
Additional statements such as the statement of shareholders equity are also important, but we will examine the three statements above for an overview of the relevant accounting terminology in English.