An Overview of Financial Statements

20110215050235The asset accounts reported on the balance sheet are listed in order of liquidity and are divided into four categories: (1) current assets, which include cash, short-term investments, accounts receivable, inventory, and prepaid expenses, (2) long-term investments, which include long-term notes receivable, land, securities, the cash value of life insurance, and special investment funds (3) property, plant, and equipment and (4) intangible assets, which include patents, trademarks, and other intangibles such as goodwill.

Liabilities are divided into tow categories: (1) current liabilities, which primarily include short-term payables, and (2) long-term liabilities, which include items such as long-term notes, bonds and mortgages payable.  The stockholder’s equity section for a corportation contains contributed capital and retained earning; the owners’ equity section for a partnership contains an account for each partner that records the cumulative balance of the partner’s contributions less withdrawals.

The income statement consists of two basic categories: revenues and expenses.  Revenues, which represent asset inflows (or liability decreases) associated with operating transactions during a given period, include sales, fees earned, service revenues, and other revenues (eg., interest, book gains).  Expenses, which represent the asset and other revenues (eg. interest, book gains.)  Expenses, which represent the asset outflows (or liability increases) required to generate the revenues, include cost of goods sold, operating expenses, (e.g. wages, rent), and other expenses (e.g., interest book losses).  Revenues less expenses equal net income.

The statement of retained earnings has four components (1) the balance in Retained Earnings at the beginning of the period, (2) net income (or loss) (3) distributions to stockholders, and (4) the balance in Retained Earnings at the end of the period.  The statement of cash flows contains three categories: (1) cash flows from operating activities (2) cash flows from investing activities, and (3) cash flows from financing activities.

This information enables external users to assess the earning power and solvency position of the company.  Assets generate cash through their use and sale, and liabilities represent cash requirements.  The income statement indicates how profitable the company’s operations have been, and the statement of cash flows shows how the company’s cash is managed.  The statement of retained earnings provides information about individual payments relative to net income.