Analysis of Financial Statements, 3rd Edition

CHAPTER 2

Financial Statements

Financial statements are summaries of the operating, financing, and investment activities of a business. Financial statements should provide information useful to both investors and creditors in making credit, investment, and other business decisions. And this usefulness means that investors and creditors can use these statements to predict, compare, and evaluate the amount, timing, and uncertainty of future cash flows.1 In other words, financial statements provide the information needed to assess a company's future earnings and, therefore, the cash flows expected to result from those earnings. In this chapter, we discuss the four basic financial statements: the balance sheet, the income statement, the statement of cash flows, and the statement of shareholders' equity.

ACCOUNTING PRINCIPLES: WHAT ARE THEY?

The accounting data in financial statements are prepared by the firm's management according to a set of standards, referred to as generally accepted accounting principles (GAAP). These accounting principles were codified July 1, 2009, which was, essentially, an integration of standards, bulletins, implementation guides, opinions, and other literature that comprised GAAP prior to this codification.2

The financial statements of a company whose stock is publicly traded must, by law, be audited at least annually by an independent public accountant (i.e., an accountant who is not employed by the firm). In such an audit, the accountants examine the financial ...