I'm Larry Walther, and this is principlesofaccounting.com, chapter 1.
In this particular module,
we're going to look at the four core financial statements.
Before we begin that though,
what I'd ask you to consider is what types of information would you want about
a particular company you were considering in investing in.
I've included this thought cloud here things that are financial in blue,
you'd wanna know about the revenues of the company, the income,
the assets, things of that nature.
You would also wanna know about, though, the things that are in red,
corporate governance, environmental responsibilities,
the management team, what brands are held by the particular company.
Accounting is focused primarily on providing the financial information.
This other information is necessary for proper decision-making and
it can be found on corporate websites, SEC filings and so forth.
The four core financial statements are the income statement, the statement of
retained earnings, the balance sheet and the statement of cash flows.
We'll look at each of these in turn.
The income statement reports the revenues and expenses and results of operations for
a particular company.
The difference between the revenues and expenses is termed the income or
net income of the company.
Here we have an example for Quartz Corporation.
Importantly, note that we're reporting the name of the corporation in the heading,
the name of the statement, the income statement and the time period.
This is a statement for a period of time so we label it as such for
the year ending December 31, 20X9.
The total revenues of the company were 765,000,
the total expenses were 650,000 and the net income was 115,000.
This brings us to the statement of retained earnings.
You already know that retained earnings is the income of the business that has not
been paid out in dividends.
Over a period of time, retained earnings will either increase or decrease.
In the first illustration, I'm showing how net income offset by some dividends
has still resulted in increase in retained earnings, but
we can also have a decrease in retained earnings during a period of time
if we have a net loss or pay excessive dividends.
This activity is reported in the second primary financial statement,
the statement of retained earnings.
Again, for a period of time, pay attention to the heading,
we're showing the beginning retained earnings plus the net income,
arriving at a sub total and then subtracting the dividends from that to
arrive at the ending retained earnings of $480,000.
The third financial statement we'll look at is the balance sheet.
You should already be familiar with the balance sheet, it reflects the fundamental
accounting equations, assets equal liabilities plus owner's equity.
This time it's not for a period of time, the dating shows that it
is at a point in time, so I've just dated December 31, 20X9.
And on that date, this company had 900,000 in assets,
200,000 in liabilities, total equity of 700,000.
Notice within equity we got retained earnings of 480,000.
That's the same retained earnings that was revealed in statement of retained earnings
in the previous slide.
The fourth financial statement is a statement of cash flow,
it's a bit more complex at least initially in your study of accounting.
It shows how cash is generated and expended during a period of time.
That is not the same thing as income, as you'll see here in a moment.
The statement of cash flows has three key sections, the operating activity section,
the investing activity section, and the financing activity section.
In the operating activity section here, we show cash received from customers.
We show cash paid for various expenses like salaries and rent and so forth.
In this business generated the net $80,000 cash from operating activities.
Not exactly the same thing as net income because some items might have been
measured as they occurred independent when the cash flows actually happened.
So if you, for example,
sell on credit, you recognized the revenue before you actually collect the cash.
So there's often time a disconnect between the cash from operations and
then net income of the business.
There's also other activities that bare for example,
we purchase land for $250,000, we pay dividends of $35,000.
And this business actually had
a $205,000 decrease in cash during the period despite its income,
a largely explainable of course by the large purchase of land during the period.
But you can begin to appreciate how important it is to study the statement of
cash flows when you consider what's happening at a particular business.
Finally I wanna close by asking you to consider how the financial statements
articulate or tie together or mesh together in a self balancing fashion.
And so if you'll study this illustration very carefully you'll note that
the revenues minus expenses gave rise to a net income of 115,000 that flowed through
into the statement of returned earnings, the green arrow showing the flow through.
Adding that to the beginning retained earnings and subtracting the dividends.
Gave us ending retained earnings of $480,000, which is also the amount
that appeared on the balance sheet, and allowed the balance sheet to balance.
Total assets now equal total liabilities plus equity.
It might be a mystery as to why that occurs, so
let's think about adding one more transaction to this particular company.
If we added one more dollar of revenue here.
Let's suppose services to customers were $750,001, and
no additional expenses were incurred.
Then income would be $115,001, and ending retained
earnings would be $480,001 and total liabilities and equity would be $900,001.
But remember, we got an extra dollar of cash, so cash would be $192,001.
The balance sheet would be preserved.
It's really a brilliant system.
It's a simple system,
but it's a brilliant system in terms of capturing all transactions in advance
into a set of articulating or self-balancing financial statements.
And these are key financial statements that investors look at when they
make decisions about business enterprises.