If financial statement users needed to gauge the health of a business by examining binders of journal entries, financial analysis would be difficult and time-consuming. However, summarization of accounting activity occurs through the drafting of the financial statements. The income statement, balance sheet, statement of changes in stockholders' equity and the statement of cash flows provide an overview of business activity in a format that is more widely understood.
The income statement summarizes a company's revenue and expense activity over its accounting period. Under United States generally accepted accounting principles (GAAP), the income statement begins with revenue, subtracts costs of sales to arrive at gross margin, and subtracts operating expenses to arrive at net income or loss. The income statement is also known as a profit and loss statement or P&L.
The balance sheet states the company's total assets, liabilities and equity at the end of the accounting period. GAAP balance sheets begin with assets, move to liabilities and then equity, with each category listing items in order of decreasing liquidity, which is the ability of a company to convert an asset or liability into cash.
Statement of Changes in Stockholders' Equity
A company's equity activity is summarized by the Statement of Changes in Stockholders' Equity (SCSE). This statement serves to reconcile the opening and closing equity balance for the company by showing all additions and subtractions to the equity accounts. The SCSE is sometimes known as the equity statement. The name of the statement also can change to reflect the legal structure of the entity. For example, as a business that is organized as a sole proprietorship does not have stock, the statement would be known as a statement of owner's equity.
Statement of Cash Flows
For businesses that use accrual accounting methods, a reconciliation to cash basis accounting is made on the Statement of Cash Flows (SoCF). While this statement is mostly an amalgamation of income statement activity and changes in the balance sheet, some investors see the SoCF as an important summary of the sources of cash for the business.
- "Principles of Financial Accounting"; Kermit Larson, et al; 2005
- Securities and Exchange Commission. "Caterpillar (Form 10-K)." Accessed July 24, 2020.
John Freedman's articles specialize in management and financial responsibility. He is a certified public accountant, graduated summa cum laude with a Bachelor of Arts in business administration and has been writing since 1998. His career includes public company auditing and work with the campus recruiting team for his alma mater.