Financial Statements
Financial statements are formal reports that provide an overview of the financial performance and financial position of a company. They provide a comprehensive summary of the revenues, expenses, assets, liabilities, and equity of a company over a specific period, usually quarterly or annually.
Financial statements are prepared in accordance with generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS). These statements provide relevant and reliable information to various stakeholders, including investors, creditors, management, employees, and regulatory authorities. They are crucial for assessing the profitability, liquidity, solvency, and overall financial health of a company, as well as for making informed decisions about investments, lending, and strategic planning.
The main types of financial statements include the income statement (profit and loss statement), balance sheet, cash flow statement, and statement of changes in equity.
TYPES OF FINANCIAL STATEMENTS
1. Balance Sheet
A balance sheet presents a summary of the assets and liabilities of the company, and the equity of shareholders, following the basic accounting equation:
Assets = Liabilities + Shareholders Equity
It helps investors, creditors, analysts, and management to assess the ability of a business to meet its financial obligations and make informed decisions about investment, lending, and other financial matters.
a) Assets: An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit. Assets can be classified as current, fixed, financial, or intangible.
Current Assets: Short-term resources that are expected to be converted into cash or consumed within one year.
Fixed Assets: Resources with an expected life of greater than one year, such as plants, equipment, and buildings.
Financial Assets: Investments in the assets and securities of other institutions, including stocks, sovereign and corporate bonds, preferred equity, etc.
Intangible Assets: Economic resources that have no physical presence, such as patents, trademarks, copyrights, and goodwill.
b) Liabilities: A liability is something a person or company owes or has borrowed, loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. following are the types of liabilities:
Current (short-term) Liabilities: Current liabilities are debts payable within one year with cash. Some examples include payroll expenses and accounts payable, which include money owed to vendors, monthly utilities, etc.
Non-Current (Long-Term) Liabilities: Long-term liabilities are debts payable over a longer period. Some examples include bonds, loans, rent, deferred taxes, payroll, pension obligations, etc.
c) Shareholders’ Equity
Shareholders’ equity also known as stockholders’ equity, is the sum of the total amount that would be distributed among its shareholders after selling all the assets and paying all the debts of the company. It gives information about the financial status of a company and indicates the ownership interest of shareholders.
The formula to calculate shareholder equity is:
Shareholder Equity = Total Assets − Total Liabilities
2. Income Statement
An income statement, also known as a profit and loss statement, summarizes the revenues, expenses, and net income of a company over a specific period, usually quarterly or yearly. It is used to determine the profitability and loss of a company by summarizing its sources of revenue and the costs associated with generating that revenue. It also helps investors, shareholders, and management to assess the financial performance of the company and make decisions regarding resource allocation, pricing strategies, and cost management.
The formula to calculate net income is:
Net Income = Total Revenue − Total Expenses
a) Revenue: Revenue refers to the gross income of a business before subtracting any expenses, or the total amount of money generated by a business over a set period of time through its primary activities, such as selling goods or services, interest earned, rental income, royalties, and other sources.
b) Expenses: Expenses refer to money spent or the costs incurred by a person, business, or organization to carry out its daily activities and operations, such as employee wages, equipment repairs, utility bills, property rent or leasing, advertising services, etc.
3. Cashflow Statement
A cash flow statement is a financial statement that provides a summary of the cash inflows (money coming in) from operating activities, investing activities, and financial activities, and cash outflows (money going out) from expenses paid for business activities and investment of a business or individual over a specific period. It provides valuable information about a company’s liquidity, solvency, and ability to generate positive cash flows.
A cash flow statement typically consists of three main sections:
Operating Activities: These activities include the cash generated or used in the daily operations of the business. It includes cash receipts from sales, payments to suppliers, wages and salaries paid to employees, interest received or paid, and income taxes paid.
Investing Activities: Any cash flows or use of funds for the purchase or sale of long-term assets or investments are considered as investing activities. It includes cash inflows from the sale of assets such as property, plant, and equipment, as well as cash outflows for the purchase of these assets or investments.
Financing Activities: These activities include cash flows related to the financing of the business. It includes cash received from borrowing (such as loans) or issuing equity (such as issuing stocks), as well as cash payments for dividends to shareholders or for repurchasing company stock.