Company financial statements

Companies also prepare a third financial statement, the statement of cash flows. Cash flows result from three major aspects of the business: (1) operating activities, (2) investing activities, and (3) financing activities. These three categories are illustrated in Table 3.

The cash flow statement is distinct from an income statement, but the two statements are similar in that they summarize activities over a period of time. In the accompanying example, cash amounting to $19 was received from the sale of the investment; the income statement included only the $5 gain—the difference between the sale proceeds and $14, the amount at which the investment had been shown in the balance sheet before it was sold. Since net income, the top lines in Table 3, included the $5 gain, the company could not include the full net income and the full cash proceeds from the sale of the investment, because that would have counted the $5 twice. Instead, Any Company, Inc., subtracted the $5 from net income (line 5 in the table) and reported the full $19 below, under cash from investing activities.

The income statement differs from the cash flow statement in other ways, too. Cash was received from the issuance of bonds and was paid to shareowners as dividends; neither of those figured in the income statement. Cash was also paid to purchase equipment; this added to the plant and equipment assets but was not subtracted from current revenues because it would be used for many years, not just this one.

Cash from operations is not the same as net income (revenues minus expenses). For one thing, not all revenues are collected in cash. Revenue is usually recorded when a customer receives merchandise and either pays for it or promises to pay the company in the future (in which case the revenue is recorded in accounts receivable). Cash from operating activities, on the other hand, reflects the actual cash collected, not the inflow of accounts receivable. Similarly, an expense may be recorded without an actual cash payment.

Table 3 adds items not requiring immediate cash payment to income (e.g., depreciation) and subtracts items that appear in the income statement but are not part of the results of operations (e.g., the gain on the sale of a long-term investment). The bottom line shows that the company’s stock of cash and marketable securities increased by $35 during the year.

The purpose of the statement of cash flows is to throw light on management’s use of the financial resources available to it and to help the users of the statements to evaluate the company’s liquidity—its ability to pay its bills when they come due.

Most large corporations in the United States and in other industrialized countries own other companies. Their primary financial statements are consolidated statements, reflecting the total assets, liabilities, owners’ equity, net income, and cash flows of all the corporations in the group. Thus, for example, the consolidated balance sheet of the parent corporation (the corporation that owns the others) does not list its investments in its subsidiaries (the companies it owns) as assets; instead, it includes their assets and liabilities with its own.

Some subsidiary corporations are not wholly owned by the parent; that is, some shares of their common stock are owned by others. The equity of these minority shareholders in the subsidiary companies is shown separately on the balance sheet. For example, if Any Company, Inc., had minority shareholders in one or more subsidiaries, the owners’ equity section of its December 31, 20__, balance sheet might appear as follows:

The consolidated income statement also must show the minority owners’ equity in the earnings of a subsidiary as a deduction in the determination of net income. For example:

A corporation’s obligations to issue financial statements are prescribed in the company’s own statutes or bylaws and in public laws and regulations. The financial statements of most large and medium-size companies in the United States fall primarily within the jurisdiction of the SEC. The SEC has a good deal of authority to prescribe the content and structure of the financial statements that are submitted to it. Similar authority is vested in provincial regulatory bodies and in the stock exchanges in Canada; disclosure in the United Kingdom is governed by the provisions of the Companies Act. In Japan financial accounting is guided by three laws: the Commercial Code of Japan, the Securities and Exchange law, and the Corporate Income Tax law.

A company’s financial statements are ordinarily prepared initially by its own accountants. Outsiders review, or audit, the statements and the systems the company used to accumulate the data from which the statements were prepared. In most countries, including the United States, these outside auditors are selected by the company’s shareholders. The audit of a company’s statements is ordinarily performed by professionally qualified, independent accountants who bear the title of certified public accountant (CPA) in the United States and chartered accountant (CA) in the United Kingdom and many other countries with British-based accounting traditions. Their primary task is to investigate the company’s accounting data and methods carefully enough to permit them to give their opinion that the financial statements present fairly the company’s position, results, and cash flows.