Financial Statements

Financial Statements and Managerial Reports

Financial statements and managerial reports are important tools that are used to keep the firms’ investors informed of financial decisions made by the organization. The key tools used include three major components. Theses components are the income statement, the balance sheet, and the statement of cash flow. This report will explain the purpose of each report and identify the components of each.

The first tool that I would like to discuss is the income statement. The main function of the income statement is to explain the profitability of an organization over a defined period. This period could be monthly, every three months, or the expected business cycle of one year (Block & Hirt, 2005). The income statement is a stair step approach that explains the profit or loss realized by a firm after each expense is deducted.

The first section of the income statement will show operating profit. Operating profit is defined as gross profit (sales less cost) less such miscellaneous expenses such as selling costs, administrative costs, and depreciation costs (Block & Hirt, 2005). Operating profit measures how efficient management is in generating revenues and controlling expenses (Block & Hirt, 2005).

Once the operating profit has been determined, interest can be deducted before applying the taxes to be paid by the firm. This will now show the net earnings or profits of the firm. Before these profits can be made available to the common stock holders, preferred stock holders will be paid their entitled dividends. After the preferred dividends have been paid to these investors, an earning per share ratio can be established and used to determine if the firm is a success in the eyes of the investors. If the results are accepted as being sufficient to the common stock holders, the firm can decide if more stock will be issued or sold to new investors. Once the earning per share ratio has been established, a firm will establish a price-earnings ratio. This ratio is an indication of the company’s future expectations. This ratio is influenced by the firms’ earnings and sales growth, risk, debt to equity ratio, dividend policies, management quality, and several other factors (Block & Hirt, 2005). A major downfall of the income statement is the fact it doesn’t consider outside events. The elimination of competition or the sale of nearby property may have an impact on the true value of the firm.

The second tool to be discussed is the balance sheet. The main function of the balance sheet is to show what the firm owns and how their assets are financed in the form of liabilities or ownership interests (Block & Hirt, 2005). Investors will be provided information concerning the holdings and obligations due by the firm. The balance sheet is a snapshot of the firm at any time. The time frame of the balance sheet starts at the beginning of the firms’ existence. The main focus of the balance sheet is the liquidity of the firm. Liquidity is simply the action of converting assets to cash (Block & Hirt, 2005). Several assets may be considered liquid. These assets include current assets (convertible to cash within one year), marketable securities, accounts receivable, inventories (raw materials, work-in-process, finished goods), prepaid expenses such as rent or insurance premiums, investments (long-term stocks, bonds, investments into other corporations), and plant or equipment expenditures. A major downfall of the balance sheet is that it does not recognize current values. Although items have value, they may not reflect future replacement costs.

The third tool is the statement of cash flow. The main purpose of this statement is to provide information about the cash flow has an impact on the daily operation of the firm. The focus is to look at cash or the equivalents that