The Role of Accounting Financial Statements

The accounting professional of small to medium sized companies must work with different types of financial statements in the course of performing accounting duties. The financial statements include the income statement, balance sheet, statement of cash and statement of retained earnings. Mastering these financial statements is the first step in becoming a successful accountant.

Accounting Financial Statements

Income Statement – presents the revenues, expenses and profit/loss of a company. The income statement, also known as the Profit and Loss statement,, the role of this statement is to show the companies’ earnings and profitability. The income statement is divided up into different parts:

  • Income from continuing operations – includes sales, cost of goods sold, operating expenses, gains and losses and income tax. These are used to compute the companies’ gross margin, operating margin and pretax margin.
  • Results from discontinued operations – the disposal transaction will result in the operations and cash flow of the component being eliminated from company operations or there will be no significant continuing involvement by the company in the operations of the component once it is disposed of-
  • Extraordinary items – gains or losses included on a company’s income statement from events that are unusual and infrequent. Usually as a result of unforeseen events.
  • Cumulative effect of a change in accounting principle – adjustments to all financial statements to reflect the change to the new account principle.
  • Net income – a company’s income minus cost of goods sold, expenses and taxes for an accounting period.
    • Net sales – amount of sales generated by a company after the deduction of returns, allowances for damaged goods and any discounts.
    • Cost of Goods Sold – the direct costs attributable to the production of the goods sold by a company, including both the cost of materials and direct labor to produce those goods.
  • Earnings per share information – the portion of a company’s profit allocated to each outstanding share of common stock and serves as an indicator of a company’s profitability.

Balance Sheet – presents the assets, liabilities, and equity of the company. The report is structured so that the total of assets equals the total liabilities. The balance sheet tells financial analysts whether they pay their bills on time, the company’s financial flexibility to acquire capital and the ability to distribute cash in dividends to the company’s owners.

  • Assets – items that provide probable future economic benefits. Listed from top to bottom in order of decreasing liquidity. The different types of assets listed on the balance sheet include:
    • Cash Equivalents – currency, coins and checks received that have not yet been deposited.
    • Short-Term Investments – any assets that are anticipated to expire within one to three years with a low risk and low return.
    • Accounts Receivable – money owed to a company by its debtors.
    • Inventory – a complete list of items including property and goods in stock.
    • Prepaid Expenses – an expenditure paid but the underlying asset that will not be consumed by a future period.
  • Liabilities – obligations that will be settled by using assets. Listed in order of expected payment. The different types of liabilities listed on the balance sheet include:
    • Accounts Payable – money owed by a company to its creditors.
    • Trade Notes Payable – the unpaid amount of promissory notes owed to suppliers of goods and services.
    • Advances and Deposits – amount of money given to a company before it is due for services partly completed.
    • Long-Term Debt – amount owed for a period exceeding 12 months from the date of the balance sheet. This can include bank loans, mortgage bonds, debenture and other obligations not due for one year.
    • Accrued Expenses – includes wages, interest and taxes indicated on the balance sheet from when the company can reasonably expect their payment, until the time the payment is made.
  • Equity – the residual interest that remains after liabilities are subtracted by assets.

The role of the balance sheet is to calculate key indicators that reveal the companies’ financial structure and ability to meet its obligations. They include working capital, current ratio, quick ratio, debt-equity ratio and debt-to-capital ratio.

  • Working Capital – the capital of a company that is used for day-to-day operations, calculated as the current assets minus the current liabilities.
  • Current Ratio – a liquidity ratio that measures the company’s ability to pay short-term and long-term obligations.
  • Quick Ratio – a measure of how well a company can meet its short-term financial liabilities.
  • Debt-Equity Ratio – a debt ratio used to measure a company’s financial leverage, calculated by dividing a company’s total liabilities by its equity.
  • Debt-to-Capital Ratio – calculated by taking the company’s debt and dividing it by the total capital.

Statement of Cashflow – presents the cash flow and outflow that occurred, breaking the analysis down to operating, investing and financing activities. Used to determine a company’s short-term viability and ability to pay bills.

  • Operating Activities – the production, sales and delivery of the company’s product and the collecting of payment from the customer. Can include purchasing raw materials, building inventory, advertising and shipping services.
  • Investing Activities – the purchase or sale of an asset, loans made to suppliers or received by customers, and payments related to mergers and acquisitions.
  • Financing Activities – the inflow of cash from investors and the outflow of cash to shareholders as the company generates income.

Statement of Retained Earnings – presents changes in equity. The report format includes sale or repurchase of stock, dividend payments and changes caused by profits or losses. For small business, the statement of changes in equity should show all changes in equity including:

  • Total Comprehensive Income – the sum of net income that must bypass the income statement because the income has not been collected yet. This includes holdings from the sale of securities and foreign currency.
  • Owners’ Investments – the amount of assets that the owner puts into the company.
  • Dividends – a sum of money paid regularly by a company to its shareholders out of its profits.
  • Owners’ Withdrawals of Capital – amount subtracted from owner capital.
  • Treasury Share Transactions – transaction of corporate stock that a company previously sold to investors and purchased back.

Interested in learning more about accounting and the role of financial statements an accountant works with on a day-to-day basis? The Accounting diploma program at Gwinnett College is designed to prepare college graduates to seek entry-level positions in the accounting and bookkeeping fields.  The college graduate may work as an accounts’ receivable or accounts payable clerk, bookkeeper, payroll clerk, accounting assistant or inventory control clerk.

Contact us to learn more about how you can become an accountant or bookkeeper today.