Understanding External Financial Statements
Companies offer external financial statements for sharing information about their business to the outside world including prospective lender and investors. Generally, external financial statements provided by companies are not much different from its internal accounting, though these can be considerably different at times. Nonetheless, external accounting statements provide an accurate and easily understandable data pertaining to companies’ fiscal status.
Internal vs. External
Personally owned businesses can have their system of internal accounting in a manner that they find most helpful provided it remains accurate and can be understood easily. For example, as an owner of a store you may find it convenient use cash based accounting for taking care of your cash flow. It simply means that only on collecting cash you document revenue and likewise, you document an expense only on spending some cash. However, external financial statements need to be made as per prescribed rules, enabling an outsider with a fundamental understanding of bookkeeping to follow the same. Generally, it would entail accrual based accounting. The difference is that in this case, you will need to document your revenue when you’re earned it and not on receiving it and similarly, you need to document expenses as and when incurred and not when paid.
Principles of Accounting
In the US, the rules and regulations to which the external financial statements of companies should conform are known as GAAP, meaning generally accepted accounting principles. The federal government has nominated the Financial Accounting Standards Board for framing and administration of those rules and regulations. It is obligatory for companies to provide details as per GAAP standards. This is meant to ensure that public gets real and accurate information about company’s financial status without the company disclosing too much of its details concerning its internal functions. When a company likes to seek any prospective business collaborator or investor or accesses a financial institution like bank for business loan, it is expected to offer statements as per GAAP stipulations.
Prevailing security laws as also GAAP demand these 4 external financial statements: income statement, equity statement, cash low statement and balance sheet. The balance sheet contains all the assets and liabilities of the company. The income statement contains a record of revenue and expenditure of the company on its main business and profit or loss as a result of its other activities. Cash flow statement keeps a track of the funds generated and spent by the company. The equity statement sums up how the net assets of the company are distributed among it owners.
In case of large companies, their external financial statements are very detailed with score of footnotes and many pages in support of information provided. On the other hand, statements of small businesses are quite simple, containing a couple of assets like cash, inventory, equipments and receivable accounts. When external statements are significantly different from internal accounting, one is required to provide explanation of the same to lenders, investors and auditors. When business operations and finances are too large, it is recommended to organize internal accounting as per stipulations of GAAP.
There is on ongoing debate if the Financial Accounting Standards Board should dilute the rules and regulations for personally owned companies and small businesses. So far, it has remained a proposal, till mid 2012.