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Financial Statement Literacy
Financial Statement Literacy
Herbert Kalman
A Silver Fox Advisor
The primary purpose of a financial statement is to provide reliable information about a company's financial performance to help owners and management make informed business decisions. These standardized reports act as a "report card" of a business's activities.
Key Objectives
- Measure Performance: They allow management to track progress against goals, identify areas for cost-cutting, and plan future budgets.
- Facilitate Decision-Making: Management uses these statements to decide whether to accelerate growth based on a company's ability to generate profit and repay debt.
- Outside parties: Management will need to provide and explain financial statements when seeking debt.
Core Financial Statements
Each of the statements serves a distinct but interrelated function:
- Balance Sheet: Acts as a "snapshot" of what a company owns (assets) and owes (liabilities) at a specific point in time. Each line item should have a supporting schedule for management use.
- Income Statement: Summarizes revenues and expenses over a period to show if the company made a profit or a loss.
- Cash Flows Statement: Shows the changes in the elements of cash flow during the reporting periods.
This article will discuss the Balance Sheet and Income Statement.
Financial Statement Example
Following is the balance sheet of ABC Distribution, Inc. (a hypothetical company) as of December 31, 2025.
Supporting the balance sheet should be supporting schedules for all accounts such as:
- Bank reconciliations
- Accounts receivable aging
- Inventory summary
- Listing of prepaid expenses and other current assets
- Summary depreciation schedule
- Notes payable transaction summary
- Accounts payable aging
- Accrued liabilities
- Changes in retained earnings
The following are examples of some balance sheet schedules.
Following is the income statement of ABC Distribution, Inc. for the year ended December 31, 2025.
Many of the income statement accounts have supporting schedules. Following are just a few examples.
Like many businesses, income earned by ABC Distribution is taxed to its owners. Owners will generally take distributions from the company to pay taxes and for personal use. The statement of retained earnings reflects such distributions and their impact on retained earnings.
Summary
These financial statements provide significant information regarding the health of the company including:
- Days of receivables outstanding-45
- Current ratio-2.96Quick ratio – 1.43
- Cash ratio - .01
- Debt to Equity Ratio-26.86%
- Debt Ratio 19.26%
- Interest Coverage Ratio 3.94%
The financial statements and supporting schedules provide management with information necessary to make good management decisions. The value of this information increases when the report is provided to management early in the month following.
Further analysis and a description of ratios will be discussed in the July SFA newsletter.
