What is a Financial Statement?
Financial statements are a collection of reports about an organization’s financial results, financial position, and cash flows. These statements are useful to:
- Track financial results for future forecasting.
- Determine if an investment is worthwhile.
- Analyze a business’ ability to generate cash.
- Calculate financial ratios that can indicate the financial position of the business.
Financial statements are comprised of three reports: balance sheet, income statement, and cash flow statement. Investors and financial analysts rely on financial statements to analyze the performance of the company and to project future earnings and the direction of a company’s stock price (if publicly held). These statements are also used by investors and creditors to evaluate a company’s financial position and earnings potential.
Income statements show the results of a company’s operations and financial activities within a reporting period. Generally, this period is for fiscal quarters (January 1 – March 31 — Q1) or fiscal years (January 1 – December 31). Income statements can be calculated using this formula:
Net Income = Revenue – Expenses
This formula results in a financial report stating whether the company operated at a net positive or net negative income level. Revenue items include operating revenue and non-operating revenue. Operating revenue is directly correlated to sales whereas non-operating revenue is income earned from non-business activities such as rental income from a property or machine, income from interest earned on cash, income from partnerships such as royalty payments or licensing, and the sale of long-term assets. Expenses are costs associated with producing a product or service, general and administrative expenses, research and development, payroll, utilities, and transportation. The main goal of the income statement is to report a company’s financial health and profitability.
A balance sheet lists a business’ assets, liabilities, and owner’s equity at a particular point in time. Essentially a balance sheet reports a business’ net worth. The balance sheet formula is:
Assets = Liabilities + Owner’s Equity
Assets are things a company owns that have value . Assets are typically things that can be sold for a profit or used to make products or services that are sold by the company. Assets are both tangible and intangible. Assets include machines, property, inventory, cash, patents, and investments a company makes.
Liabilities are monetary amounts that a company owes to others. Liabilities include money owed to suppliers, payroll to employees, or taxes owed to the government.
Owner’s equity is money that is left if a company sold all of its assets and paid off its liabilities. This sum of money belongs to owners in the company.
The above formula is used to balance a company’s assets to liabilities and owner’s equity. A good rule of thumb is to remember that assets must always equal liabilities and owner’s equity.
Cash Flow Statements
Cash flow statements report a company’s inflows and outflows of cash during a reporting period . Cash flow statements show how a company is generating cash and how the company is using its cash. This information is useful for creditors, investors, and potential investors due to seeing how a company operates and its ability to recover from its cash outflows. A cash flow statement includes three sections: operating activities, investing activities, and financing activities.
Operating activities include any use of cash to continue operating the business and selling its products or services. Investing activities include any use of cash to make investments into the long-term future of the company. Financing activities include any use of cash from investors, banks, and shareholders. Essentially, cash flow statements show the net increase or decrease in cash for a period along with how the company achieved the net increase or decrease.