Financial statements are historical documents. They report the past. Since there’s no way to directly know the future, we use financial statements—past performance—to forecast the future. If the accounting system operates under GAAP and the financial statements are prepared according to GAAP, we can use a variety of forecasting and analysis tools to predict the future performance of the business. This approach has many flaws, but it’s the most reliable of a shaky lot. (Shamans reading chicken guts and monkeys throwing darts are two discarded forecasting tools, although the monkeys still have a few adherents.)

From recording information in the general journal through the accounting cycle, the raw accounting information has three main purposes—financial data for external users and management, management cost results to guide decision making, and tax information for governmental authorities. Management can prepare several reports from this data. For present purposes, we will focus on three reports: the balance sheet, the income statement, and the statement of cash flows. Each of these statements highlights a particular portion of the accounting equation and its corollaries, to help you determine meaningful things about the activity of the enterprise. Recall The Three Questions. How much money came in? Where did the money go? How much money is left?

The income statement answers the first question. The revenue and expense accounts are added up for a given period of time, typically a year. The statement of cash flows solves the second question. It tracks where cash came from what it was used for. It also tracks activity for a given time period. Finally, the balance sheet polishes off the third of the three questions. It shows what’s left in the company. It’s the only one that uses a point in time, typically the end of the fiscal year.

All the gozinta and gozouta transactions of the business can be assigned to one of three categories of activities—operating, investing, and financing. Operating activities are what make the profits for the enterprise. Investing activities support operations through buying and selling the long-term assets needed to carry out operations. Those assets are paid for through the financing activities that come up with the cash and repay borrowed money.

Table 3-1. Financial statements and categories of activities

As we step through the financial statements, we can see where each category of activity fits.

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