In general, a company prepares financial statements to demonstrate its financial well-being to investors. These statements include income statements, balance sheets and statements of cash flows. In addition to reflecting a company’s operating performance during a specific time period, each financial statement also indicates how a company manages the investments it makes that do not relate to the company’s production of goods or services. While a balance sheet and statement of cash flows reveal the amount of money a business invested, an income statement reveals the company’s investment earnings.
A company typically uses accrual accounting to prepare its income statement. Accrual accounting mandates that a business match its revenues with the expenses the company incurred to earn them during the same time period. Regardless of when cash exchanges hands between a company that produces goods and a person purchasing the company’s wares, a company records a sale and the costs paid to ensure the sale when they occur. If, for instance, a person buys a magazine subscription by paying for 12 magazines at once, the periodical’s publisher records the individual’s payment in installments to match the expenses the publisher pays to produce each monthly magazine instead of recording the full amount the person paid for his annual subscription at once.
An income statement demonstrates a company’s ability to generate revenue or profits from its operations. An income statement subtracts different groups of expenses from a company’s revenue before revealing the company’s net profit or loss at the bottom of the statement. If a company has investments such as bonds or stocks issued by another business, the last section of an income statement reports the company’s earnings on these investments.
A balance sheet demonstrates that a company’s assets equal the total of the company’s liabilities plus the equity held by the company’s owners. A balance sheet breaks down a company’s assets and liabilities into current and noncurrent categories. A company’s current assets include investments the business can convert into cash within an operating cycle such as bonds and securities that will mature within a year. A company’s noncurrent assets include long-term investments that will require more than one year to reach maturity.
Statement of Cash Flows
Unlike an income statement, a company’s statement of cash flows reports when a company actually collects or spends money. A statement of cash flows would report receiving a person’s one-time payment for a 12-month magazine subscription in a lump sum, for instance, rather than matching a portion of the money to production expenses over a period of time. A statement of cash flows displays the money a business receives and spends in accordance with the type of activity that led to the collection or expenditure of money. A statement of cash flows reveals the amount of money a business chooses to invest during a given period of time as part of the company’s investment activities.
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