Financial statements are official documents that show the financial activities and status of a company.
They are used to provide details about the company’s financial performance, including its revenues, expenses, profits, assets, liabilities, and equity.
Financial statements are a valuable resource for investors, creditors, and other stakeholders who seek to make informed decisions about an organization.
By carefully examining these statements, these parties can gain valuable insight into the organization’s financial well-being and identify potential risks and opportunities.
In essence, financial statements serve as a window into the financial health of an organization, allowing stakeholders to make sound financial decisions based on accurate and reliable information.
There are three main types of financial statements:
- Balance Sheet
- Income Statement
- Cash Flow Statement
The balance sheet is a snapshot of the organization’s financial position at a particular point in time, and it shows the value of the organization’s assets, liabilities, and equity.
- Assets: Assets are resources that a company owns and can use to generate income, including cash, investments, and property.
- Liabilities: Liabilities are what a company owes to others, such as debts and loans.
- Shareholders’ Equity: Equity represents the remaining value of a company’s assets after all liabilities have been paid off.
An income statement, also known as a profit and loss statement, is a financial document that summarizes a company’s revenues, expenses, and net income over a specific period of time, typically a quarter or a year. The income statement provides a comprehensive view of a company’s financial performance by showing how much money it earned and how much it spent during a particular period.
- Revenue: Revenue refers to the total amount of money earned by a business over a specific period. This can include revenue from sales of goods and services, as well as other types of income, such as interest or rental income. Revenue is usually the top line item on an income statement and is used to calculate other important financial metrics, gross profit, and net income.
- Expenses: Expenses are the costs associated with running a business, including salaries and wages, rent, utilities, insurance, marketing expenses, and more. These expenses are subtracted from a company’s revenues to determine its net income or profit. Expenses can be divided into two broad categories: operating expenses and non-operating expenses. Operating expenses are those incurred in the normal course of business, such as salaries, rent, and utilities. Non-operating expenses, however, are those which are not directly related to the core business activities, like interest on loans, income tax, or losses on investments.
Cash Flow Statement
The cash flow statement provides information about an organization’s cash inflows and outflows over a particular period of time.
- Operating Activities: Operating activities in a cash flow statement refer to the movements of cash resulting from a business’s primary revenue-generating activities, including costs of goods sold, labour costs, and operational expenses. These activities can include the selling of goods or services, the collection of accounts receivable and the payment of accounts payable. Some examples of cash inflows from operating activities include the collection of customer payments, the sale of inventory, and interest received on investments. Cash outflows from operating activities can include the purchase of materials and supplies, expenses incurred in the production of goods or services, and payments made to employees and suppliers.
- Financing Activities: Financing activities refer to transactions that involve the raising and repayment of funds to investors and creditors. These transactions are an essential part of a company’s operations, as they help to sustain and grow its business. In the cash flow statement, financing activities are typically located at the bottom section of the report, under the heading ‘Cash Flows from Financing Activities.’ The financing activities section of the cash flow statement comprises primarily two types of transactions: raising capital from investors and borrowing money from creditors. Some common ways in which companies raise funds from investors include issuing bonds, stocks, or other securities. On the other hand, sources of borrowed funds include loans from financial institutions and other sources of financing.
- Investing Activities: Investing activities outline the cash inflows and outflows from the purchase, sale, or disposal of long-term assets. These assets may include property, plant, and equipment, investments in financial securities, or other investments that are not considered part of a company’s normal course of business. The “Investing Activities” section of the cash flow statement typically provides investors with a clear idea of the capital expenditures a company has undertaken during a period. It also highlights any cash generated or utilized from the sale of investments, including stocks, bonds, and other securities.
It is critical that financial statements are accurate and reliable, as they are used to make important decisions about an organization.
To ensure accuracy and reliability, financial statements are often audited by independent accounting firms who review an organization’s financial records and provide an opinion on the accuracy of the financial statement.