Under accrual accounting, several main financial statements are prepared to provide a comprehensive overview of a company's financial performance and position. These statements are crucial for decision-making, financial analysis, and reporting purposes. The main financial statements prepared under accrual accounting include the income statement, balance sheet, and statement of cash flows.
1. Income Statement: The income statement, also known as the profit
and loss statement or statement of earnings, presents a company's revenues, expenses, gains, and losses over a specific period. It reflects the company's ability to generate revenue, control costs, and ultimately determine its profitability. The income statement follows the accrual basis of accounting, recognizing revenues when earned and expenses when incurred, regardless of cash flow. It typically includes line items such as sales revenue, cost of goods sold, operating expenses, interest
income/expense, and taxes
. The net income or loss derived from the income statement is a key indicator of a company's financial performance.
2. Balance Sheet: The balance sheet provides a snapshot of a company's financial position at a specific point in time. It presents the company's assets, liabilities, and shareholders' equity. The balance sheet follows the fundamental accounting equation: Assets = Liabilities + Shareholders' Equity. Assets represent what the company owns, such as cash, inventory
, property, plant, and equipment. Liabilities represent what the company owes to external parties, such as loans, accounts payable, and accrued expenses. Shareholders' equity represents the residual interest in the company's assets after deducting liabilities. The balance sheet helps assess a company's liquidity, solvency
, and overall financial health.
3. Statement of Cash Flows: The statement of cash flows provides information about a company's cash inflows and outflows during a specific period. It classifies cash flows into three categories: operating activities, investing activities, and financing activities. Operating activities include cash flows from day-to-day business operations, such as cash received from customers and cash paid to suppliers. Investing activities include cash flows from buying or selling long-term assets, such as property, plant, and equipment, or investments in other companies. Financing activities include cash flows related to raising capital or repaying debt, such as issuing or repurchasing shares
, borrowing or repaying loans. The statement of cash flows helps assess a company's ability to generate and utilize cash effectively.
These three financial statements work together to provide a comprehensive view of a company's financial performance, position, and cash flow. They are prepared under the accrual accounting framework to ensure that revenues and expenses are recognized when earned or incurred, regardless of the timing of cash receipts or payments. By utilizing these financial statements, stakeholders can make informed decisions, evaluate a company's financial health, and compare its performance with industry benchmarks.