Financial reporting maintains the official records of a business’s financial activity, in the form of specific financial statements. The purpose of financial reporting is to strike the right balance between a complete accounting of the relevant data, and a legible, understandable presentation. The “audience” of such reports can, and generally will, include parties within the company who need to know the business’s position and progress; labor unions and parties with a similarly vested interest in the business’s well-being; shareholders or prospective investors and their agents; external authorities such as lending institutions and government tax authorities; and the general public.
Financial reports provide a picture of the company’s activity at a particular time or over a particular period of time. The standards to which reports are held are determined both by the Generally Accepted Accounting Principles, which adhere in the United States, and the International Financial Reporting Standards (IFRS) adopted by the International Accounting Standards Board. In the United States, adherence to IFRS is being phased in gradually, with all American companies expected to adopt them in their accounting practices by 2014. Currently, IFRS obtains in the European Union (EU), Australia, the nations making up the Cooperation Council for the Arab States of the Gulf, India, Pakistan, Hong Kong, Malaysia, Singapore, and Russia.
Most sets of accounting standards call for four basic financial statements. The balance sheet presents the company’s financial situation at a specific point in time—generally the end of the fiscal year. The company’s assets and liabilities are listed in full. The assets minus the liabilities are the net worth of the company—the shareholders’ equity, as it is sometimes called. The balance sheet is the most basic financial statement, a product of the double-entry bookkeeping system (though individuals employing the single-entry bookkeeping system used for balancing personal checkbooks can also determine their net worth with such a balance sheet). Of course, the net worth of a company (or an individual) is not the same as its available cash, since much of what it owns will be in assets such as equipment, inventory, real estate, intellectual property, and so on. These various assets will be listed on the balance sheet. Contingent liabilities are also listed: liabilities that may or may not need to be paid at some point in the future, such as those owed from lawsuits pending, or the expense of upholding a warranty or money-back guarantee. Ideally, the balance sheet will note the likelihood of loss associated with each contingent liability (large companies issuing warranties have a general sense, as demonstrated by their past fiscal records, of how much those warranties cost them).
An income statement, profit and loss statement, or simply P&L, is narrower than the balance sheet, and accounts for the company’s net income. The net income is also called the bottom line, coming as it does at the end of a sequence of subtractions (the expenses), which follow the top line: the revenue, all the money collected by the company. The net income is how much the company is “actually making,” over a given period of time. The income statement will note different kinds of expenses, such as the depreciation associated with capitalized fixed assets, the administrative expenses spent on running the business, and the sales expenses incurred by the process of getting the product to the customer (including sales commissions, freight, and advertising). Irregular items are noted in a special section, such as discontinued operations, natural disasters, relevant changes in government or industry regulations that affect the business, and changes to the business’s accounting practices. The income statement also reports the earnings per share.
The statement of retained earnings records the changes in a company’s retained earnings over a specific period of time. It is usually presented along with a balance sheet and a P&L, and essentially expands the coverage of the changes to the company’s net worth, through profits, losses, changes in assets, and so forth.
The cash flow statement is of special interest to lenders, contractors, and other parties interested in letting the company be in debt to them. It looks specifically at the company’s cash inflow and outflow, which has special importance in the short term because a company that is worth a great deal but has little cash on hand will have difficulty paying its bills.
Financial reports are included as part of a company’s annual report, made available to shareholders. Blue chip corporations have traditionally issued expensive, elaborate annual reports, often hardcover and filled with photographs; as the internet has provided faster ways of making information available, this has become less common.
- James Bandler, How To Use Financial Statements (McGraw-Hill, 1994);
- Thomas R. Ittelson, Financial Statements (Career Press, 1998).
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