Introduction to Financial Statements

Financial statements are an important management tool. When correctly prepared and properly interpreted, they contribute to an understanding of the current financial condition, problems and possibilities of a company.

This explanation has been prepared to help financial and non-financial managers and owners make better use of the information in the financial statements.

Specifically, this brochure describes three financial statements:

The Balance Sheet, which is also referred to as the Statement of Financial Condition or Statement of Financial Position.

The Income Statement which is sometimes called the Statement of Operations or the Profit and Loss Statement.

The Statement of Cash Flows, which replaced the now-obsolete funds flow statement (formally known as the Statement of Changes in Financial Position).

These statements are prepared and presented using technical terms and rules that are becoming increasingly complex. Interpretation of these statements may be a formidable challenge to many managers and owners.

We firmly believe that - no matter how technically correct they are financial statements are not useful unless they are actually used in making business decisions. When the statements "gather dust" because managers and owners do not understand what they are saying, we feel an obligation to help. We hope this Guide to Financial Reporting will help you to use financial statements in making decisions, monitoring your business and planning for future growth.
 

The Balance Sheet is a "snapshot": It represents, at a moment in time, the financial position of the business entity. It needs to be compared to other "snapshots" to provide meaningful information on changes in financial position. For that reason, the balance sheet from the preceding year is usually provided.

The other primary financial statements - the Income Statement and the Statement of Cash Flows - present a summary of activities over a period of time, usually a fiscal year. The Income Statement presents revenue less associated expenses and the resulting net income. The Statement of Cash Flows provides information about the sources and uses of cash.

Other Elements of Financial Reports

In addition to the basic financial statements, most financial reports which have been prepared for delivery to third parties (i.e., those outside the reporting entity) will have a section of Notes to Financial Statements.

The Notes to Financial Statements set forth the major accounting principles used in developing the amounts reported in the statements (where a choice was made from among alternative generally accepted accounting principles or "GAAP"), and also provide additional details about major accounts and transactions, Examples of the latter include details about long-term leases, long- and short-tern debt (including interest rates and maturities), transactions with related parties and contingent liabilities and commitments,

Financial reports may also contain supplementary schedules, which provide more detailed information about major expense captions (such as administrative expenses) or other items appearing in the basic financial statements, Except in rare instances, the presentation of supplementary schedules is not required under generally accepted accounting principles, but represents a choice made by the preparer of the financial statements.

If independent accountants have been associated with the financial statements, their report will be included with the statements. The report will identify what professional services were provided -- an audit, a review or a compilation - and indicate what conclusions, if any, were reached regarding the financial statements in the case of an audit, the independent accountant will provide positive assurances that the financial statements "present fairly" the financial position and results of operations in accordance with generally accepted accounting principles, if it can be concluded that such is the case. If the statements contain a departure from generally accepted accounting principles, or if the auditor's examination was subject to a scope limitation, or if there are material uncertainties affecting the financial statements - which may include doubt about the entity’s ability to continue as a going concern - these must also be described in the auditor's report In a review engagement, at best the accountant will express negative assurance--- i.e., that based on limited procedures no reason was found to doubt that the financial statements were fairly presented - An accountant performing a compilation merely assembles the financial statements, and offers neither positive nor negative assurances, The level of assurance offered by the independent accountant on supplementary schedules may be lower than that offered on the basic financial statements. Thus, the basic statements may have been reviewed, and the accountant may have also reviewed the supplementary information, or alternatively the accountant may only have compiled the supplementary data. If the basic financial statements have been audited, the supplementary information may have also been subjected to audit procedures, or, if not, the accountant's report will note that the supplementary data have not been audited.

Using the Financial Statements to Analyze the Performance of the Business

The information contained in the basic financial statements (including the notes thereto) can and should be used to provide insight into the financial strength and earnings capacity of the business, This extends beyond such single statement captions as "net income" and necessitates that relationships between accounts be examined. While an almost unlimited number of such ratios and comparisons are possible, a relatively small group of these are traditionally the object of most attention.

The nature of the analysis depends on the perspective of the reader. For example, the short-term note holder would be primarily concerned with the company's ability to pay its current obligations. The holder of long-term debt might look to both historical and projected earnings and cash flows. The stockholders, current and future, would share a viewpoint similar to that of the long-tem debt holder, with perhaps more concern for earnings (vis-à-vis cash flows) than the creditors might exhibit.

The management of. a company is concerned with all of the above factors and, in addition, needs financial information that is useful on a daily basis.

A selection of the financial ratios that are most often computed to analyze the business is: Ratios to Measure Return on Investment, Ratios to Measure Safety and Liquidity and Ratios to Measure Operating Efficiency.

SUMMARY

Financial analysis involves many different approaches; the ratio analysis presented on the preceding pages is only one of several means of gaining an understanding about a company from the financial data. Other approaches, such as the careful study of the financial statement notes, examination of the company's accounting policies and an analysis of operations by division or product- line should also be considered. We can assist in developing other procedures that will be useful on a day-to-day operating basis.

We want your financial statement to be used and useful. If you would like further information, please contact us today.