Accounting is the process of managing the resources of a company in an effective manner such that profits as well as other objectives of the company are attained. Each and every business enterprise despite their size must employ accounting procedures in its system if at all it wants to be successful (Lalith, 2011, p.1). Accounting is broadly grouped into two classes namely financial and management accounting. Financial Accounting primarily involves the preparation of financial reports of the organisation which the organisation’s management relies on when making organisational decisions. The financial reports prepared give a summary of the transactions that the business enterprise has been involved in during a certain period of time (Lalith, 2011, p.1). The common financial reports prepared by most organisations include; budgets, cash books, cash flow statements, tax reports and the balance sheet just to mention but a few.
The Four basic Financial Statements
These four financial statements interrelate with each other on the basis of the accounting equation so as to fulfil the purpose of accounting.
The Income Statement
The income statement in other words known as the profit and loss account is the initial statement formulated. The income statement is prepared on an annual basis and shows the profit or loss in gross or net form which the organisation has achieved in the course of that year. In essence, the income statement is the core financial statement in any organisation because almost all other financial statements use data from this report in their preparation and analysis. For example the balance sheet utilizes the net profit or loss figures obtained in the income statement to balance the accounting model. The cash flow statement also generates much of its data for calculation from the income statement.
The Balance Sheet
The balance sheet is a common financial statement which is prepared to show how much the organisation is worth as at a specific date by indicating the financial position of the organisation. The balance sheet gives a list of the assets, liabilities and the capital equity of organisation. It is usually prepared after the income statement since it uses data from it. For example it borrows the retained earnings figure from the income statement which it uses to balance off the accounting equation.
Cash flow Statement
This is another basic financial statement though it is among the most tedious reports to prepare. It shows how much cash is available in the organisation to settle the short term liabilities for example, accrued salaries and short-term assets like current expenses. This is indicated by monitoring the flow of cash in and out of the organisation. It highly depends on the income statement and the balance sheet from which it gets its data to perform the analysis. It is thus in most instances prepared after the balance sheet and the income statement have been prepared.
Statement of Retained Earnings
Also known as the statement showing owner’s equity this is prepared to establish any alterations in the retained earnings of a given periodic year. it is therefore prepared once the income statement has been prepared so that it checks out if the earnings of that year have been retained or used for example in terms of dividends to the shareholders.
Importance of the Financial Statements
From the above discussion, it can be clearly depicted that financial statements are prepared for the benefit of the organisation and its stakeholders. Financial statements are thus prepared for both the internal and external environments of the organisation (Welch, 1999, p.1). Once the financial accountants have formulated the financial statements they convey them to the organisation’s managers who use the information therein to make concrete conclusions and decisions about the progress of the organisation. Among the major decisions that can be made include those of capital investments, mergers and acquisitions, dividend and rights issue among others.
To begin with, the financial statements are of great importance to the investors of the organisation. Before an investor decides on making an investment in an organisation, they have to know the real value of that organisation as at that time. This, they get from looking at the balance of the balance sheet which shows a list of all assets, liabilities, as well as equity. The income statements which gives an indication if at all the company has been operating through losses or profits is another financial statement that the investor critically analyses before making the decisions of buying, holding or selling their stocks (Eisen, 1999, p.1).
The creditors also have to look at the credibility of the organisation before loaning the organisation. The creditors therefore go through the organisation’s current financial statements from which they determine whether or not to issue credit. Despite their position in the organisation, the employees are also entitled to the information found in the financial statements. The employees need the surety that the organisation is in a position to pay them their dues lest they be working with no pay. They also need transparency in their payment figures, for example, if the organisation is generating high profits with the aid of the employees it should be able to remunerate reasonable salaries.
Eisen, P. (1999). Financial Accounting. Web.
Lalith, R. (2011). The purpose of Accounting. Web.
Welch, C. (1999). Basic Purpose of Accounting. Web.