Series on Reading and Understanding 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 financial statements. Balance Sheet Income Statement Cash Flow Statement

The Balance Sheet is a “photograph”: It represents, at a moment in time, the financial position of the business entity. It needs to be compared to other “photographs” to provide meaningful information on changes in financial position. For that reason, the balance sheet as of the end of one or more preceding years is usually presented with the balance sheet as of the end of the current year.

The Balance Sheet (or Statement of Financial Position/Condition) is so named because it represents the following equation:

Assets (Resources of the business) =
Liabilities (Amounts owed to outside creditors) +
Equity (Capital provided by owners)

At any point in time this basic equation holds true, although the amounts assigned to the individual elements will fluctuate. 

Assets increase or decrease as resources are obtained, disposed of, become more or less valuable, or are used up (expensed) in the course of operations.

Liabilities increase or decrease as obligations to suppliers, lenders, and other creditors are incurred or repaid. In some cases, the amounts of liabilities need to be estimated (referred to as “accruals”) and are subject to adjustment (upward or downward) in later periods. In limited circumstances, recorded liabilities are contingent upon the occurrence of future events, and may not be paid in part or full. Equity increases or decreases as a result of income or loss from operations of the business. It also increases when the owners contribute capital to the business and decreases when the capital is withdrawn or dividends are paid.

Current Assets are those assets of a company which are reasonably expected to be realized in cash, sold, or consumed during the normal operating cycle of the business or one year, if less. These assets generally include cash and cash equivalents such as money market accounts, certain investments in debt and marketable equity securities, accounts receivable, inventories, and certain prepaid expenses such as insurance.

Property and Equipment are assets of a durable nature and a relatively long life that are used in the regular operations of the business.

Accumulated Depreciation is the aggregate of charges to expense or to write off the cost of property and equipment over its estimated useful life. It is the result of a bookkeeping entry and does not represent any current cash outlay.

Other Assets may consist of intangibles, such as goodwill, patents or trademarks; assets, such as the cash surrender value of life insurance; and prepaid expenses, including unexpired multi-year insurance premiums.

In certain industries, such as real estate, assets are presented without being classified in the categories shown in this example.

Current Liabilities are those obligations that are reasonably expected to be paid using current assets. These liabilities generally include notes payable, current maturities of long-term debt, accounts payable, income taxes payable, and accrued expenses such as salaries and interest.

Long-term Debt is debt less current maturities and includes those obligations that are not expected to be paid within one year. Bonds and mortgages are common long-term liabilities.

Deferred Income Taxes result from differences between taxable income and accounting income. Common items giving rise to deferred income taxes include depreciation methods that are allowed by tax law but do not match the estimated useful life of the asset, deferred compensation that is not deductible until paid but gives rise to currently reported expense, and certain prepaid income such as rent received by the business in advance of the date it is due, which is deferred to later periods for accounting purposes, but which is taxed currently.

Common Stock and Preferred Stock, if any, represent the ownership interests in a corporation. The preferred stock will have preferential rights as to dividends or in the event of liquidation of the business. Common stock represents the residual ownership interest.

Additional Paid-in Capital is the difference between the amount of money obtained by a corporation on the issuance of its own stock and the par value of the stock.

Retained Earnings are the portions of all the company’s past earnings that were not distributed to the owners.