Why It Matters

Figure 5.1 Financial statements are needed to understand a firm’s financial position and performance. (credit: modification of work “Drowning by Numbers” by Jorge Franganillo/flickr, CC BY 2.0)

Chapter Outline

5.1 The Income Statement

5.2 The Balance Sheet

5.3 The Relationship between the Balance Sheet and the Income Statement

5.4 The Statement of Owner’s Equity

5.5 The Statement of Cash Flows

5.6 Operating Cash Flow and Free Cash Flow to the Firm (FCFF)

5.7 Common-Size Statements

5.8 Reporting Financial Activity

People say that accounting is the “language of business.” Using the language of business, accountants are able to communicate the financial performance and health of a firm via four key financial statements. These statements are the income statement, balance sheet, statement of owner’s equity, and statement of cash flows. Each statement provides different insights into a firm’s performance and financial health. Though some users may favor one or two statements over another, they are best used together to get a full picture.

In this chapter, you’ll be introduced to a firm called Clear Lake Sporting Goods. Clear Lake Sporting Goods is a small merchandising company (a company that buys finished goods and sells them to consumers) that sells hunting and fishing gear. It needs financial statements to understand its profitability and current financial position, manage cash flow, and communicate its finances to outside parties like investors, governing bodies, and lenders. We will walk through each financial statement, its components, how they are connected, and how financial statement users understand each one.