Which financial statement reports the financial position of a business over a period of time?
Financial reporting is a vital accounting process that communicates your company’s financials to internal stakeholders (management) and external stakeholders (customers, investors, lenders, regulators, etc.). There are four main financial reports — also called financial statements — used to communicate your financial data.
These financial statements are often issued quarterly and annually. Many companies issue monthly statements as well during month-end closing for internal analysis. What is GAAP?Generally Accepted Accounting Principles (GAAP) is a set of accounting principles, procedures, rules, and standards governing how public companies must report their financials in the United States. The Financial Accounting Standards Board (FASB) is responsible for issuing and updating GAAP. Private companies do not have to follow GAAP — but doing so brings you many benefits. Adhering to GAAP makes for better communication. Entrepreneurs, investors, lenders, and other parties are all familiar with GAAP. By following GAAP in your financial reporting, you can convey your company’s financial information to these parties more easily. GAAP makes it easier to compare performance against competitors for the same reason. Since GAAP is so widespread, reporting according to its standards provides you ample opportunity to analyze how you stack up against similar companies. GAAP Vs. IFRSThe International Financial Reporting Standards (IFRS) is the international counterpart to GAAP. IFRS standardizes financial reporting around the world so that financial statement users can make informed analyses and decisions. IFRS is often confused with the set of standards it replaced — International Accounting Standards (IAS). IAS was retired in 2001 in favor of IFRS when the International Accounting Standards Board (IASB) replaced the International Accounting Standards Committee (IASC). The SEC has discussed merging GAAP with IFRS. As of now, however, GAAP remains a separate set of standards. Like with GAAP, private companies in the US do not have to adopt IFRS. IFRS guidelines may make sense for some private entities, but we’ll cover GAAP financial statements in this article. The Four Financial StatementsThe Balance SheetThe balance sheet provides a snapshot of your business’s financial positions at one point in time. For that reason, it is sometimes called the statement of financial position. Balance sheets display information on three types of accounts:
Knowing the balance sheet formula — also called the accounting formula — can help you understand how each category plays off the others. This formula is as follows:
In other words: you, the owner, own any assets left over after you fulfill your debts. The Income StatementThe income statement — colloquially known as the profit & loss statement, or P&L statement — demonstrates your profitability over an accounting period. Income statements are split into several categories that shine a light on your business’s performance.
Income statements are excellent tools for identifying why you are not profitable and how to improve. For example, you could be selling a product with a low COGS at a high price, yet have narrow profit margins. However, upon closer inspection of your operating expenses, perhaps you are spending a fortune on advertising. Knowing this, you could explore ways to streamline your advertising campaigns and cut costs. Even if revenues drop a bit, you could increase profits if your advertising costs decrease by a significant amount. The balance sheet and the income statement work well enough together for many smaller businesses to use them exclusively. Their balance sheet summarizes their financial health, while their income statement helps them boost profits and cut costs. But you may need other financial statements based on how you do your financial reporting. The Cash Flow StatementIf your business follows the accrual method of accounting, you’ll need a cash flow statement. The cash flow statement shows you how cash actually moved during the period — whereas the income statement illustrates income/expenses earned/incurred but not received/paid. Quick example: if you sold Widget X for $100 on credit, you would list $100 in revenue on your income statement. However, since you have not received the cash yet, you would record nothing on the cash flow statement. Say the customer paid you in the next accounting period. You’d record a positive $100 cash flow on the cash flow statement, but you wouldn’t record anything on the income statement. There are three parts to a cash flow statement. Each one describes a different type of activity that can cause a cash flow.
In accrual accounting, the cash flow statement is an essential companion to the balance sheet and income statement — because those reports don’t tell the whole story. You could be making a substantial amount of sales on credit. Additionally, you earn $50 in interest on a loan you made to another business. The balance sheet and income statement look nice, as you have plenty of accounts receivable and revenue. However, upon viewing the cash flow statement, you see that you only brought in $50. That may indicate that you need to be more aggressive in A/R collections. The Statement of Retained EarningsCompanies often hold onto some profits to invest in future projects for growth. That’s where the statement of retained earnings, or the statement of owner’s/shareholder’s equity, comes in. This report outlines the change in a company’s retained earnings — profits left over after distributing dividends to shareholders — over a period. External parties, such as investors or lenders, use the statement of retained earnings to understand how you plan on using your profits to grow your business. The statement of retained earnings is relatively simple.
You can prepare the statement of retained earnings as a standalone report, but many add it to the bottom of the balance sheet. Financial statements are complicated enough as is. If you’re switching over to GAAP for the first time, preparing your financial statements can be quite daunting. CFO Hub’s experts are here to help. Whether you’re adjusting to GAAP or a long-time GAAP user, our team of experts will create accurate financial statements that are helpful to your stakeholders and enable you to make better business decisions. Contact us today for a free no-obligation consultation. |