The Securities and Exchange Commission requires that publicly traded firms comply with certain reporting standards. One of those standards is that companies will publish certain financial statements that conform to the generally accepted accounting principles (GAAP).
The four most common financial statements are
The point of these financial statements is to provide useful information to external and internal stakeholders. The information is considered to be made useful when it meets the following four criteria.
- Relevant– Information has to be capable of making a difference.
- Reliable– Information should be put together so that it is dependable.
- Benefits– The beneficial outcome of the information must outweigh the cost of the information.
- Materiality– Information must be large enough or have a large enough impact to affect a decision if it is present.
To begin to show how the four financial statements work and what information they present, we will begin by taking a look at the balance sheet.
The balance sheet is the financial statement that shows what a firm has (assets) and how the firm got them (liabilities and owner’s equity). In the balance sheet the sources and uses of the firm’s funds are described for a point in time.
The balance sheet can be thought of as a snapshot. It only shows the items that a firm has at a certain period of time. This is because the very next day, new sales will be made and debt will be incurred.
The balance sheet is called so because it contains the articles that “balance” the accounting equation below.
Assets: These are economic resources that are owned or controlled by the company. These resources offer the company a future economic benefit. On the balance sheet the assets are listed in order of liquidity. The more easily the asset is converted to cash the closer to the top it will be.
A few examples of assets are:
- Accounts Receivable
Liabilities: These are the business obligations that the business has to pay cash, provide services, or transfer assets in any way to another party. The liabilities show the claims against the assets by debtors.
Liabilities are listed in the order of maturity on the balance sheet. The ones that are due the soonest are listed first.
A few examples of liabilities are:
- Accounts Payable
- Wages Payable
- Notes Payable
- Unearned Revenue
- Bond Revenue
Every liability has three time pieces associated with it. The liability was created in the past, it exists currently, and it will require future action.
Owner’s Equity: Also known as Shareholder’s Equity, this is the owners claim on the assets after the liabilities.
Examples of owners’ equity are:
- Common Stock
- Preferred Stock
- Retained Earning
- Paid-in Capital Excess of Par Value
- Paid-in Capital from Treasury Stock
In this equation, assets will always equal liabilities plus the owners’ equity. Using simple math this equation can be manipulated to solve any of the items in the equation.