Understanding the Financial Statements

Let’s recap quickly what we talked about in Lesson 1 (the introduction to accounting). We talked about a motivated business owner named Carl (proud owner of Carl’s Clockworks). Carl’s never-ending love for clocks and his dream to be an entrepreneur led him to want to create his business. However, Carl soon realized he would need capital to get started. He talked with the bank and with rich investors but they both told him that they would need to see some financial accounting numbers before they would even consider giving him money. Carl comes to the realization that accounting is important and apparently useful in the business world.

Financial Statements (The Foundation of Accounting and Business)

Carl is a bit sad after being shot down.

The hero of our story, Carl, left empty handed after talking with both the bank and some wealthy investors (he still couldn’t believe the investors weren’t willing to hand over the money after the pocket watch handout). Carl loafed around for a few days feeling sorry for himself and tinkering with his clocks. After a few days, he decided to pull himself together and try to make those stupid financial statements (or whatever they’re called) that the banker (Sarah Malin) suggested.

Let’s take a look at the standard financial statements needed by all businesses, including Carl’s Clockworks. Entire lessons in the future will be dedicated to each statement listed below. For now, we’re simply going to introduce them to Carl (and you).

1. The Balance Sheet – Also referred to as the Statement of Financial Position (this financial statement reports on all of the assets, liabilities, and equity of the business).
2. The Income Statement – Also referred to as the Statement of Operations (this financial statement reports on the revenue and expenses of a business).
3. The Statement of Cash Flows (just like it sounds, this statement reports all the cash flows of an organization).

You and Carl should take some time to memorize the names of these three financial statements. If you are going to be doing business anytime in the near future you’ll need to know a lot about these statements. These three financial statements are tremendously important to CEOs, CFOs, accountants, investors, managers, bookkeepers, and just about anybody who does business. In fact businesses that trade stock in the United States are required by law to make these three statements available to the public so that people who buy stocks (investors) can make informed decisions.

With a quick Google search you, and Carl, could find the financial statements for Google, Microsoft, Wal-Mart, and other popular companies. Many smaller companies, like Carl’s Clockworks, that don’t trade stock publically also have financial statements. A small business has financial statements because bankers and investors need financial information about the company in order to determine whether or not to invest money in the company.

In the next lesson Carl works toward obtaining some of these financial statements so that he can get financing for his company.

Next Lesson: Lesson 2.1 – Sample Financial Statements