Reporting Financial Condition and Profit Performance

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Business managers, lenders, and investors need to know the financial condition of a business. They need a report that summarizes its assets and liabilities, as well as the ownership interests in the excess of assets over liabilities. And, they need to know the profit performance of the business. They need a report that summarizes sales revenue and expenses for the most recent period and the resulting profit or loss. Chapter 1 explains that a summary of cash flows, though very useful in its own right, does not provide information about either the financial condition or the profit performance of a business.

Financial condition is communicated in an accounting report called the balance sheet, and profit performance is presented in an accounting report called the income statement. Alternative titles for the balance sheet include "statement of financial condition" or "statement of financial position." An income statement may be titled ''statement of operations" or ''earnings statement." We'll stick with the names balance sheet and income statement to be consistent throughout the book.

The term "financial statements," in the plural, generally refers to a complete set including a balance sheet, an income statement, and a cash flows statement. Informally, financial statements are called just "financials." Financial statements are supplemented with footnotes and supporting schedules. The broader term "financial report" usually refers to all this, plus any additional narrative and graphics that accompany the financial statements and their supplementary footnotes and schedules.

Exhibit B on page 9 presents the balance sheet for the company example introduced in Chapter 1, and Exhibit C on the following page presents the income statement for its most recent year. Its formal cash flow statement for the year is discussed in Chapters 13 and 14; the summary of cash flows for the company presented in Chapter 1 has to be modified slightly—as we'll see later.

The format and content of the two primary financial statements as shown in Exhibits B and C apply to manufacturers, wholesalers, and retailers—businesses that make or buy products that are sold to their customers. Although the financial statements of service businesses that don't sell products are somewhat different, Exhibits B and C illustrate the general framework of balance sheets and income statements for all businesses.

Side Note: The term "profit" is avoided in income statements. "Profit" comes across to many people as greedy or mercenary. Also, the term suggests an excess or a surplus over and above what's necessary. I should point out that you may hear business managers and others use the term "profit & loss," or "P&L statement" for the income statement. But this title hardly ever is used in external financial reports released outside a business.



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