Taking care of the financial accounting for your business means knowing how to (and who should) read the financial report. This list of questions and answers is a guide for finding accounting information on a financial report and how to interpret the financial data.
Q: Who should read the financial report of a business?
A: Its internal managers and its external investors and lenders. The standard-issue financial statements in the financial report are designed with external users in mind.
Q: Where do I find the bottom-line profit made by a business?
A: In the last line in the income statement, which summarizes the sales revenue, income, expenses, and losses of a business for a quarter or year. The amount of bottom-line net income depends, to some extent, on whether the business chooses conservative (cautious) or liberal (optimistic) accounting methods for recording its sales revenue and expenses.
Q: Where do I find the summary of a business’s assets and liabilities?
A: In the balance sheet, which also reports the sources of its owners’ equity. The dollar amounts reported in a balance sheet reflect the historical transactions of the business. The sales revenue and expenses in the income statement propel many of the assets and liabilities in the balance sheet.
Q: How can I find out whether a business has a healthy cash flow?
A: Read the business’s statement of cash flows. To learn the cash flow generated from making profit, look in the first section of the statement of cash flows. Never forget: Sales revenue and expenses in the income statement are not cash flows; the income statement is the wrong place to find cash flows.
Q: Are the bottom-line profit and other key numbers in the financial statements I’m reading objective, above-board, and trustworthy?
A: There’s a fair chance that the business has, within tolerable limits, manipulated the amounts reported for its sales revenue and expenses and for certain assets and liabilities, which is generally called massaging the numbers. Savvy investors and lenders know about this process and treat the numbers accordingly. But investors and lenders do not tolerate accounting fraud (also called cooking the books), which refers to deliberate falsifications and gross distortions.
Q: Does its balance sheet tell me what the business is worth?
A: The short answer is no, but read on. The market price of a business, or its stock shares, depends mainly on its predicted profit performance in the future. Its income statements over the recent past are the basis for forecasting its future profit performance. Its balance sheet reports the assets the business uses to earn profit and the liabilities it is saddled with. A strong balance sheet helps the market value of a business, and a weak balance sheet hurts market value.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
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