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Understand
Business Financial Statements:
Crash Course
Businesses operate to achieve various goals.
To meet these goals a business must achieve two primary objectives:
To earn a satisfactory profit and to remain solvent (be able
to pay its debts). If a business fails to meet either of these
primary objectives, it will not be able to survive in the long
run.
Financial statements are accounting reports used to summarize
and communicate financial information about a business. Three
major financial statements - the income statement, the statement
of changes in financial position, and the balance sheet - are
used to report information about the business's primary objectives.
These financial statements are the end result of the accounting
process. Each of them summarizes certain information that has
been identified, measured, recorded, and retained during the
accounting process.
Income
Statement: An income statement is a financial statement
summarizing the results of a business's earnings activities
for a specific period of time. It shows the revenues, expenses,
and net income (or net loss) of the business for this period.
Revenues are the prices charged to the business's customers
for goods and services provided. Expenses are the costs of
providing the goods or services. The net income is the excess
of revenues over expenses; a net loss arises when expenses
are greater than revenues.
Statement
of Changes in Financial Position: A statement of changes in financial position is a financial
statement summarizing
the results of a business's financing and investing activities
for a specific time period. The results of the business's financing
activities are shown in a "Sources" section of the
statement; this section includes sources from operations and
other sources.
Balance
Sheet: A balance sheet summarizes a business's financial
position on a given date. It is alternatively called a statement
of financial position. A balance sheet lists the business's
assets, liabilities, and owner's equity.
Assets: Assets are the economic resources of a business that
are expected to provide future benefits to the business. A
business may own many assets, some of which are physical in
nature, such as land, buildings, supplies to be used in the
business, and goods (inventory) that the business expects to
sell to its customers. Other assets do not possess physical
characteristics, but are economic resources because of the
legal rights they convey to the business. These assets include
amounts owed by customers to the business (accounts receivable),
the right to insurance protection (prepaid insurance), and
investments made in other businesses.
Liabilities: Liabilities are the economic obligations (debts)
of a business. The external parties to whom the economic obligations
are owed are referred to as the creditors of the business.
Usually, although not exclusively, legal documents serve as
evidence of liabilities. These documents establish a claim
(equity) by the creditors (the creditors' equity) against the
assets of the business. Liabilities include such items as amounts
owed to suppliers (accounts payable), amounts owed to employees
for wages (wages payable), taxes payable, and mortgages owed
on the business's property. A business 'may also borrow money
from a bank on a short or long-term basis by signing a legal
document called a note, which specifies the terms of the loan.
Amounts of such loans would be listed as notes payable.
Owner's
Equity: The owner's equity of a business is the owner's
current investment in the assets of the business. For a partnership,
the owner's equity might be referred to as the partners' equity;
for a corporation, stockholders' equity. The owner's equity
is affected by the capital invested in the business by the
owner, by the business's earnings from its operations, and
by withdrawals of capital by the owner of the business.
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