An entity must be accountable to their shareholders. In order to achieve this necessary goal, an entity is required to disclose specific financial material to individuals that have an interest in the company. There are four central financial components involved when reporting on financial activity of an entity: the balance sheet, income statement, statement of cash flows, and statement of changes in owner’s equity. The interplay between these documents constitutes the seamless reconciliation of all economic activity within an entity. This information is externally oriented and is invaluable to shareholders. It provides them with a snapshot of the financial position of a company, the profits or losses over a certain period of time, the source and allocation of incoming and outgoing monies over the same period, and the changes that occur within the owner’s equity during this period. This accessibility to critical economic information creates the link between external users and an entity. It allows for the tracking of historical performance, financial changes of an entity, and keeps shareholders informed. There is nothing more notably valuable to a shareholder or interested investor than being informed; these documents allow for this and begin by disclosing a picture of the entity’s financial position.

The balance sheet or statement of financial position offers the investors information on the financial position of an entity in a point of time. It is a statement that represents the entity’s assets, liabilities, and owner’s equity. The balance or accounting equation (A = L + OE) denotes a balance between both sides of the equation (i.e., the dollar amount of the assets should be equal to the liabilities less the owners equity). This summation of the entity’s financial position can be prepared at anytime but is usually disclosed at the end of the fiscal reporting period. The balance sheet works in concert with the income statement and the statement of changes in the owner’s equity.

The income statements provide critical information to an interested investor or shareholder. It represents the profits or losses of an entity over a period of time. Moreover, it calculates and denotes the net income of an entity and is the first link to the balance sheet.

The link from the income statement is expanded in the statement of changes in the owner’s equity. This statement is comprised of two central components: paid-in-capital and retained earnings. The net income is a component of retained earnings and is added to this section from the income statement. The link between the balance sheet and the income statement is thus derived from the retained earnings component of the statement of changes in the owner’s equity. On a time-line representation of two balance sheets separated by one fiscal year, an external user will see the change in the income statement reflected in the retained earnings component of the statement of changes in the owner’s equity, thus leading to an increase or decrease to the owner’s equity on the new balance sheet. Armed with this information, a reasonably astute user will be able to discern profits or losses, recognize changes in the owner’s equity, and make comparisons between balance sheets.

Lastly, the statement of cash flows identifies the sources and allocation of monies throughout a period of time. It is comprised of three main components: cash flows from operating activities, investing activities, and financing activities. The end balance in the cash flows statement is thus reflected in the cash section of the new balance sheet under current assets. The statement of cash flows provides information on an entity’s liquidity and solvency and can be helpful in identifying whether it can support its financial obligations. Additionally, it helps to assess any changes that may occur in assets, liabilities and owner’s equity.

The important interplay between these documents, working in conjunction, is an invaluable asset to the external user. These components of financial reporting are designed to convey the critical financial information of an entity to the external users. Since most stakeholders of an entity are not privy to or involved in the decisions of daily managerial activities, these financial documents provide a clear summation of an entity’s economic activity. They provide an entity’s financial position at a point in time, the profits or losses over a period of time, changes in owner’s equity over that period, and a representation of cash flows during that period. This combination of financial information provides external users with the financial roadmap needed to make informed decisions about an entity. They guide the decision making process of an investor or potential investor and are indispensable in this regard.

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