What is a Financial Statement?

Financial statements are an important tool for managing your company. They're a snapshot of your company's finances that provide critical data on its success. They're also the building blocks for charting your future path. Bankers, investors, and others use financial statements to analyze the health and liquidity of your organisation and make decisions that affect it.

 

A financial statement is a collection of financial data about your company. Financial statement analysis and organization can help you draw conclusions about your company's financial health. Line-by-line items as well as total amounts of what you're looking at are included in statements. 

 

The income statement, balance sheet, and cash flow statement are the three basic financial statements. During a period, each sort of financial statement reports different facts (e.g., month, quarter, etc.). Statements provide information on numerous aspects of your company's financial health. 

 

Financial statements are created for a range of distinct periods. The most recent fiscal year is covered by annual financial statements. Interim financial statements can be prepared on a monthly, quarterly, or semi-annual basis.

 

Year-end statements often have fewer components than interim statements. They might not have a cash flow statement or a statement of retained earnings, for example. To make comparisons easier, financial statements usually include information for both the current and preceding periods. 

 

A financial statement spanning the period January 1 to December 31, 2023, for example, would include financial statements for that year as well as the prior year—January 1 to December 31, 2022.

 

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Characteristics of Financial Statements

 

1. Better understanding

 

Stakeholders are unable to use financial data that they do not comprehend. An organization must show financial data in such a way that it aids in the comprehension of the underlying data.

 

2. Relevance

 

Users can assess whether or not they are making the best economic decisions by looking at relevant data. A set of data is also relevant if it has the power to correct or validate existing mental processes and facts.

 

3. Reliability

 

Information is only dependable if it is devoid of errors, particularly material errors, is full, and is not biased. Relevance isn't enough for trustworthiness. In order to be useful in decision-making, a set of data must be both dependable and relevant.

 

Purpose of a Financial Statement

 

Internally and externally, financial statements serve a variety of purposes.

 

The financial statements of a company are expected by external stakeholders (such as investors and debtors). These statements provide information about a company's present financial position, growth, resources, and cash flow prospects.

 

Furthermore, financial statements can assist investors in making economic decisions by providing a better knowledge of a company's development and potential opportunities.

 

Financial statements are also important for internal purposes as a tool for measuring corporate performance and changes. These reports are also taken into account when making crucial financial (and/or managerial) decisions because they provide a clear and accurate visual depiction of your company's current financial status.

 

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Components of Financial Statements

 

There are various statements in a set of financial statements, some of which are optional. If an external accountant compiled or reported the statements, they would begin with a report from the accountant. The following are the three most important financial statements:

 

The balance sheet  (sometimes also known as a statement of financial statement)

 

The income statement is a financial statement that shows how much money (which may include the statement of retained earnings or it may be included as a separate statement)

 

The Statement of Cash Flows. The cash flow statement and notes to the financial statements are normally shown after the balance sheet and income statement. 

 

The accrual foundation of accounting is used to create external financial statements, which means that assets and liabilities are recorded when they are committed to, and revenue and costs are recorded when they are incurred (rather than when they are actually paid).

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Components of Financial Statement

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1. The Balance Sheet

 

A balance sheet provides a picture of your company's current financial situation. It informs you about the assets you hold and the liabilities (debts) you owe at any given time. 

 

The balance sheet is the most important declaration in terms of "what we have." The balance sheet indicates what the business possesses (cash, accounts receivable, and equipment) as well as what it owes (liabilities such as accounts payable and loans). 

 

Any leftover difference between these two figures (assets and liabilities) represents the equity stake of the owners. These three figures should always be in proportion. The balance sheet depicts the state of the company at a certain point in time.

 

• Assets

 

Your company's assets are anything valuable it has. Assets on the above-mentioned Bench balance sheet include money in a checking account and money in transit (being transferred from another account)

 

Equipment, furniture, land, buildings, notes receivable, and even intangible assets like patents and goodwill can all be included in total assets.

 

• Liabilities

 

Liabilities are the debts that you owe to others. The only liability in our example balance sheet is a bank loan. Credit card debt, mortgages, and accumulated expenditures like utilities, taxes, or pay owed to employees can all be included in total liabilities.

 

• Equity

 

After removing liabilities from assets, equity is the remaining value of the company. This could be retained revenue, which is money the corporation has already earned. Private or public stock, as well as an initial investment from your company's founders, can all be used as equity.

 

As an example, let's say you opened an internet store and deposited $3,000 in the account as operational capital (to pay web hosting costs and other expenses). That $3,000 would be shown as owner's equity on your balance sheet before you had made a transaction.

 

It's vital to remember that equity refers to your company's "book worth." If you wanted to sell your firm, it's not the market worth. Buyers typically pay more than the book value of a firm when selling it, based on factors such as the company's annual earnings, the market worth of tangible and intangible property it holds, and more.

 

Balance Sheet Formula

 

Remember this formula to understand how the three categories on the balance sheet interact:
 

Assets – Liabilities = Equity

 

Simply defined, whatever worth (equity) your company has is equal to what it owns (assets) less what it owes (liabilities).

 

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2. Income Statement

 

The income statement, also known as the profit and loss statement or the statement of revenue and expense, focuses on the company's earnings and expenses during a specific time period.

 

The income statement is a crucial component of a company's performance reports that must be filed with the Securities and Exchange Commission (SEC). While a balance sheet offers a snapshot of a company's financials as of a specific date, an income statement reports income over a specific time period, with the length of the period indicated by the heading.

 

Revenue, costs, profits, and losses are the four main components of the income statement. It makes no distinction between cash and non-cash receipts (cash sales vs. credit sales) or cash vs. non-cash payments/disbursements (purchases in cash versus purchases on credit).

 

The income statement is one of three primary financial statements used to reflect a company's financial performance over a certain accounting period, with the balance sheet and the statement of cash flows being the other two.

 

Components of Income Statement

 

The following is a list of some of the most important details seen on an income statement. Regulatory restrictions, various business needs, and accompanying operating activities may all influence the format of this document.

 

• Sales or Revenue

 

This is the first section of the income statement, and it provides a summary of the company's total sales. There are two sorts of revenue: operational and non-operating. 

 

The revenue generated by a company's principal activities, such as creating a product or delivering a service, is referred to as operating revenue. Non-operating revenue comes from non-core business activities including system installation, operation, and maintenance.

 

• COGS (cost of goods sold)

 

This is the overall cost of sales or services, often known as the cost of goods or services manufactured. Keep in mind that this simply accounts for the costs of the things you sell. In most cases, indirect costs such as overhead are not included in COGS.

 

• Profit

 

Net sales minus total cost of items sold in your business equals gross profit. Net sales refers to the amount of money you made from the things you sold, whereas COGS refers to the amount of money you spent to make those goods.

 

• Gains

 

A gain is an increase in an organization's income as a result of a favorable event. Gains refer to the amount of money the company makes from various commercial activities, such as the sale of an operational segment. 

 

Earnings from one-time non-business activities are also counted as profits for the company. Revenue is money a company receives on a regular basis, whereas gain is money earned from the sale of fixed assets, which is an uncommon activity for a firm.

 

• Expenses

 

Expenses are the costs that a business must incur in order to create profit. Equipment depreciation, staff compensation, and supplier payments are all examples of regular expenses. Operating and non-operating expenses are the two basic types of business expenses. 

 

Operating expenses are those incurred as a result of a company's core business activities, whereas non-operating expenses are those incurred as a result of non-core business activities. 

 

Operating expenses include sales commissions, pension payments, and salaries, whereas non-operating expenses include obsolete inventory charges or lawsuit settlements.

 

3. The Cash Flow Statement

 

The cash flow statement shows how much money came in and went out of your business over a specific time period. Cash flow statements (also known as a statement of cash flows) are normally prepared solely for organizations that employ the accrual accounting method of accounting. 

 

This is due to the fact that the accrual approach allows a company's income statement to include money earned but not yet received, as well as expenses incurred but not yet paid. 

 

A cash flow statement depicts changes over time rather than money quantities at a specific point in time. It takes data from a company's balance sheet and income statement and reorganizes it.

 

The cash flow statement's bottom line displays the period's net increase or reduction in cash. Cash flow statements are typically broken into three sections. Each section examines the cash flow from one of three types of tasks: (1) operating, (2) investing, and (3) borrowing.

 

• Operation Task

 

The first section of a cash flow statement examines the cash flow generated by a company's net profits or losses. This component of the cash flow statement reconciles the net income (as reported on the income statement) to the actual cash received from or used in the company's operating activities for most companies. 

 

It does this by adjusting net income for any non-cash items (such as reversing depreciation charges) and any cash provided or used by other operating assets and liabilities.

 

• Investing Task

 

The cash flow from all investing activities, which often include purchases or sales of long-term assets like property, plant, and equipment, as well as investment securities, is shown in the second half of a cash flow statement. 

 

Because cash was utilized, a company's cash flow statement would show the purchase of machinery as a cash outflow from investing operations. The revenues from the sale of some investments from an investment portfolio would show up as a cash inflow from investing operations because it supplied cash to the company.

 

• Financing Activities

 

The cash flow from all financing operations is shown in the third section of a cash flow statement. Cash raised via the sale of stocks and bonds, as well as borrowing from banks, are common sources of cash flow. Similarly, repaying a bank loan would be considered a cash flow use.

 

Also Read | Difference between Saving and Investing

 

Bottom Line: Why do you need to produce a Financial Statement?

 

We understand that preparing and reading financial accounts can appear to be an enormous amount of information at first look - and you're correct! But you don't have to be afraid of them since once you get your business processes and records under control, you'll be able to save time and money for both you and your company!

 

Financial statements can assist you in quickly interpreting and processing your accounting activity, whether you are a small firm operating from home, a sole trader, a freelancer, or pretty much anything else.