Financial Statements and the Decision-Making Process

A company uses financial statements to make future business decisions. Some of these statements are: (1) an Income Statement, which presents the revenues and expenses of a company for a specific period of time. (2) A Retained Earnings Statement, which summarizes the changes in retained earnings that have occurred for a specific period of time. (3) A Balance Sheet, which reports the assets, liabilities, and stockholders' equity of a business at a specific date. (4) A Statement of Cash Flow, which summarizes information concerning the cash inflows (receipts) and out-flows (payments) for a specific period of time.

Income statements report on the success or failure of a company's operations by reporting its revenues and expenses, such as liabilities, the debts and obligations of a business. Liabilities represent claims of creditors on the assets of a business. If the company's revenue exceeds its expenses, there will be net income; otherwise, there will be a net loss. Investors want this information to base their decisions about buying and selling the company's stock. They want to know what the company's future performance will be. They want to protect their stockholders' equity, the stockholders' claim on total assets.

Retained earnings statements are used by company to decide how much of their income will be paid to stockholders as dividends. A company cans choose to pay all profits to stockholders but few do so because they want to reinvest the money or use it for future growth. A company may not want to pay out high dividends because they are concerned about protecting their assets, or the company's resources. Retained earnings are Income less dividends paid.

The balance sheet reports the company's resources and claims to those resources. There are only two types of claims: liabilities and stockholders' equity. A company analyzes the balance sheet to determine if they are financing their business more by creditors or owners of their stocks. Creditors analyze a company's balance sheet to determine the likelihood that they will be repaid. Stockholders look to the balance sheet to confirm financial stability of the company along with looking at comparative statements, a presentation of the financial statements of a company for multiple years.

A cash flow statement compares the amount of cash provided by operating activities with the amount of cash used by investing activities. Any deficiency in cash from operating activities must be made up with cash from financing activities. Investors and creditors are interested in this information in their analysis of a company's cash positions. Cash is the company's most important resource and it is important to know what is happening to it.

All of the financial statements are inter-related and are used in making decisions by the managers of the company, investors, and creditors.

Sources:

The Uses of Financial Statements

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