Evaluating Financial Statements
One of the responsibilities of most managers or business owners is to evaluate the data being captured and reported by accountants. In order to perform this function correctly however, a manager or owner must first understand how to properly interpret this data and in turn use it to evaluate the success or failure of the company's operations. This data comes in three basic forms: The income statement, the balance sheet, and the statement of cash flows.
The income statement is the most basic of three financial statements. The main purpose of the income statement is to measure the profitability of a company over the course of a specified time. The gross profit is determined by calculating all sales over that time frame and deducting the total cost of goods purchased over this same time. Remember that gross profit does not take into consideration the outside costs of doing business such as labor, utilities, and other operational expenses. When these additional expenses are consider, the result is the operating profit of the company. The final step in evaluating an income statement is to deduct the additional expenses that are not related to operational matters such as interest and taxes. Income statements are a valuable tool in evaluating financial results, however, if not used with a balance sheet the information provided by an income statement does not hold the same value.
The purpose of a balance sheet is to assess the company's assets and how the financing or ownership of these assets constitutes either a liability or an interest. Unlike a time specific picture painted by the income statement, a balance sheet is a snapshot of a particular point in time. This snapshot can be of one particular date or a snapshot of all transactions that have occurred since the beginning of the company. On the balance sheet, the assets are listed in order of liquidity, or its cash value. Some examples of liquidity (assets) include marketable securities, inventory,...
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