What Are Financial Statements?
Financial statements are written documents that track the various activities and highlight how a company is performing financially. They are often written and reviewed by accountants, accounting firms, government agencies, etc., to ensure and verify that a company is following tax laws and documenting the correct information, which may also be used for investment purposes.
Use of Financial Statement Information
Current investors use the data collected on financial statements, potential investors, and financial and market analysts to analyze how a company performs. For the company, this allows them to make informed decisions on allocating resources and funds when planning. For investors and analysts, this will enable them to predict the direction the company is headed in terms of stock price.
The financial statement consists of:
- Balance sheet.
- Income statement.
- Cash flow statement.
The balance sheet summarizes the company’s assets, liabilities, and stockholders’ equity for a certain period. As a result, analysts and external analysts can see how a company is performing in the current year, how it performed in previous years, and how the company is expected to perform in the future.
The majority of balance sheets are formatted according to the following formula:
Assets = Liabilities + Shareholders’ Equity
Assets are things that companies own that bring value to the company. Assets can be physical, such as a truck that is being used to deliver the product a company is selling, or they can be nontangible, such as software that the company uses to help with the services the company provides.
Liabilities include things like money that the company owes to another company, service provider, or individual. This includes government tax, paying off debts, paying rent if they do not own the building that they operate in, etc.
Shareholders equity is the company’s net worth, which is obtained if the company were to sell all of its assets and pay off all liabilities. The money left over belongs to the company’s owners and shareholders and is known as the shareholder’s equity.
In a balance sheet, the company’s assets must equal the sum of the liabilities and shareholders’ equity. If the balance sheet does not balance, an error would have occurred, such as improper recording of assets and liabilities and the omission of transactions in the company.
An income statement is a report that shows the company’s revenues, expenses, and net income over a certain period, which is usually a year. Payments minus costs give the net income, showing whether the company has made a net loss or a net profit.
Revenues are the amount of money that the company has generated by selling goods or services provided to customers.
Expenses are the amount of money that flows out of a company. Examples include:
- Paying wages.
- Paying for services provided to the company by an outside source.
- Cost of maintaining equipment used by the company.
Net income is the value obtained once the company has factored in all revenues and expenses. If total revenues are more significant than total expenses, the company has made a net profit; the opposite is valid for a net loss.
Cash Flow Statement
The cash flow statement is a report that shows the movement of cash in and out of the company over a certain period. The main difference between the income statement and the cash flow statement is that the income statement shows whether a company has made a profit or loss; however, the cash flow statement highlights money the company has generated.
The cash flow statement has three categories, and these are:
- Operational activities cash flow.
- Investing in activities cash flow.
- Financing activities cash flow.
Operating activities cash flow is the amount of cash that flows in and out of the company based on the regular company activities such as selling of products or providing a service.
Investing activities cash flow is the amount of cash that flows in and out of the company based on what the company is investing in, such as buying or selling long-term assets, investing in other companies or individuals.
Financing activities cash flow is the amount of cash that flows in and out of the company based on the money used to fund the company so that it operates. Examples include obtaining bank loans, selling company shares, etc.
Summary of Key Points
- Financial statements are written documents that keep track of business activities and company financial performance.
- The balance sheet indicates a summary of the company’s assets, liabilities, and the amount of equity that belongs to stockholders over a certain period
- The income statement shows the company’s profit or loss as it records revenues and expenses. Once expenses are removed from revenues, the resulting figure is the net profit or net loss.
- The cash flow statement (CFS) documents the movement of cash in and out of a company. It measures the company’s ability to generate cash to fund the expenses used in business operations, pay off debts, and support any ongoing or future planned projects.
Are Your Financial Statements in Order?
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