Financial Statements
Lesson:
There are three financial documents that are critical in financial accounting:
- Balance Sheet - This is the personification of the accounting equation. It shows a snapshot in time of the firm's assets, liabilities, and owner equity.
- Income Statement - This is a record of business success over a period of time. In other words, are your assets growing faster than your liabilities?
- Statement of Cash Flows - This shows what's happening with your money. Where is coming from and where is it going.
Many new students get confused why the statement of cash flows matters. After all, as long as you have more assets than liabilities, you could always turn assets into cash. Unfortunately, sometimes it's hard to sell assets on short order to get the cash you might need to pay for things. Additionally, understanding where cash is coming from will often help managers better understand what the business is doing, but you'll learn more about that later.
Karen Brown, owner of Michael Jones, inc., is trying to figure out which financial document she needs to examine.
-
Karen needs to make a large purchase in cash and isn't sure if she has enough.
Which financial document should she be looking at?
Answer:
- She should be looking at the balance sheet.
Explanation:
-
This is a trick question. Many people will mistakenly look to the cash flow statement, but remember. The cash flow statement describes the change in cash, not its total amount.
Whenever we want to know how much cash we have, we need to look at a snapshot in time, not a measure of change that is taking place.