How to Read a Financial Report: Wringing Vital Signs Out of the Numbers

Chapter 15. FOOTNOTES TO FINANCIAL STATEMENTS

Financial Statements—Brief Review

Exhibit 15.1 at the start of the chapter shows the principal components of the three financial statements of a business and shows that footnotes are included with the three statements. Footnotes are the fourth essential part of every financial report—the three financial statements plus their footnotes. This chapter explains the reasons for and problems with footnotes.

Before discussing footnotes, it's a good idea at this point to review the three financial statements of a business that I explain in previous chapters.

1. Balance Sheet: Also called the statement of financial condition, the balance sheet is a summary of the company's assets, liabilities, and owners' (stockholders') equity at the close of business on the last day of the income statement period. To understand a balance sheet, you need to understand the differences between the basic types of assets (inventory versus property, plant, and equipment, for instance), and the differences between operating liabilities (mainly accounts payable and accrued expenses payable) versus debt on which the business pays interest. Also, you should know the difference between the two different sources of owners' equity—capital invested by the owners in the business versus profit earned but not distributed to owners, which is called retained earnings.

2. Income Statement: This is the summary of a company's sales revenue and expenses for the period (the profit-making activities ...