Financial statements are a collection of written records presenting an overview of an organization’s financial position, cash flows, and results. Financial statements are usually audited by accountants, government agencies, and other firms and organizations who verify the accuracy of a business’s financial reporting for financing, investing, or tax purposes.
What is the Purpose of Financial Statements?
Financial statements are crucial for businesses to prepare and analyze for the following reasons:
- Gauging a business’s ability to generate cash
- Offering an accurate idea of whether a business can pay back its debts
- Identifying any profitability issues while tracking and calculating expenses and revenue
- Providing insight into financial relationships that can represent the condition of a business
- Investigating business transactions
- Helping companies make informed business decisions
What are the Types of Financial Statements?
Financial statements are used by investors, market analysts, and creditors to evaluate a company’s financial health and earnings potential.
The major financial statements are:
- Balance sheets
- Income statements
- Cash flow statements
- Statements of shareholders’ equity
What is a Balance Sheet?
A balance sheet provides a summary of a company’s assets, liabilities, and stockholders’ equity as a snapshot in time. The date at the top of the sheet informs you when the snapshot was taken, which is generally at the end of the reporting period. However, balance sheets do not show the money that goes into or out of a company’s accounts.
Continue ahead for a breakdown of the items on a balance sheet.
- Cash and cash equivalents are liquid assets, which can include Treasury bills and certificates of deposit
- Accounts receivables: The amount of money owed to the company by its customers for the sale of its product and service.
- Debt, including long-term debt
- Wages payable
- Dividends payable
- Shareholders’ equity is a company’s total assets minus its total liabilities. It represents the amount of money that would be returned to shareholders if, all of the assets were liquidated and all of the company’s debt was paid off
- Retained earnings are part of shareholders’ equity and are the number of net earnings that were not paid to shareholders as dividends
What is an Income Statement?
An income statement illustrates the revenue a company has earned over a period of time. It also displays the expenses incurred while earning that revenue. The top of an income statement lists the gross sales revenue. Returns and allowances are then subtracted from the gross amount, so the second line of the statement shows the net sales a company possesses.
Companies make deductions at each step in the income statement for specific costs or other operating expenses associated with earnings. The last line of the statement notes the company’s net earnings or losses, which tells you how much a company has earned or lost in that fiscal year.
Overall, the leading purpose of an income statement is to convey details of profitability and the financial results of business activities. But, it can be very beneficial in showing whether sales or revenue is increasing when comparing multiple periods.
What is a Cash Flow Statement (CFS)?
Cash flow statements summarize the movement of cash and cash equivalents in and out of a company. They take information from a company’s balance sheet and income statement and reorder it to inform you whether or not the company generated cash. Cash flow statements are divided into three main parts to assist in reviewing the cash flow from each of these activities: operating activities, investing activities, and financing activities.
What is a Statement of Changes in Equity?
A statement of changes in equity derives from the balance sheet statement by offering additional information about shareholders’ equity during a reporting period. Shareholders’ equity statements help disclose stock sales and repurchases by the business reporting the information.
The beginning balance is set up across the top of the grid-like report, which includes additions and subtractions from the balance located in the middle of the report. Ending balances are placed at the bottom of the report after additions and subtractions are incorporated. Also, there should be figures totaled at the top and bottom of the report for the total amount of beginning and ending shareholders’ equity.
Columns in the report may incorporate the following:
- Treasury stock
- Accumulated other comprehensive income
- Totals column
- Common stock
- Preferred stock
- Retained earnings
What is the Consolidated Financial Statement?
Consolidated financial statements are statements of an entity with multiple divisions or subsidiaries. Companies often use the term consolidated loosely in financial reporting referring to the aggregated reporting of their entire business collectively. But, the Financial Accounting Standards Board defines consolidated statement reporting as reporting of entities structured with a parent company or subsidiaries.
Consolidating financial statements requires companies to incorporate and combine all of their financial accounting functions to create consolidated financial statements. They will show results on standard balance sheets, income statements, and cash flow statement reporting. Filing a consolidated financial statement is mainly based on the amount of ownership the parent company has in the subsidiary.
What is the Government Financial Statement?
Government financial statements disclose all financial transactions for the government for the year. These statements are not a budget but a history listing the revenue collected and the amounts the government spent. A state of activities and a statement of net position are usually included. And while not necessary, balance sheets can be incorporated too. These statements are generally intended for state and local governments.
What is the Personal Financial Statement?
A personal financial statement is a document or spreadsheet that outlines an individual’s financial position at any given point in time. It typically consists of general information about the individual, such as name and address, along with a breakdown of total assets and liabilities. The statement can help people track their financial goals and wealth and be used when they apply for credit.
Updated personal financial statements help individuals track how their financial health improves or deteriorates over time. These tools can be invaluable when consumers want to change their financial situation or apply for credit, such as a loan or a mortgage. By knowing their current financial standing, consumers can avoid unnecessary inquiries on their credit reports and the hassles of declined credit applications.
What Are the 3 Most Important Financial Statements?
The three most important financial statements are:
- Balance Sheet
- Income Statement
- Cash Flow Statement
All of these statements illustrate the assets and liabilities of a business, its revenues, and its costs, along with its cash flow from operating, investing, and financing activities.
What are the Financial Statement Ratios and How is it Calculated?
There are several ratios investors use to calculate information on financial statements and use the results to evaluate companies. Keep in mind that desirable ratios vary for each industry.
- P/E Ratio
The P/E ratio is Price per share divided by earnings per share. Suppose a company’s stock sells at $20 per share and the company earns $2 per share. That means the company’s P/E ratio is 10 to 1. The company’s stock sells at 10 times its earnings.
- Current ratio
The current ratio assesses whether or not it is wise to invest in a given company. It results from a concise formula from numbers that can be found on the balance sheet. You can compute the current ratio by dividing a company’s total current assets by its total current liabilities in dollars.
- Operating margin
The operating margin compares a company’s operating income to net revenues. Both of these numbers can be found on a company’s income statement. To determine the operating margin, you must divide a company’s income from operations (before interest and income tax expenses) by its net revenues.
- Debt-to-equity ratio
The debt-to-equity ratio compares a company’s total debt to shareholders’ equity. Both of these numbers can be discovered on a company’s balance sheet. To calculate the debt-to-equity ratio, you have to divide a company’s total liabilities by its shareholder equity.
What are the Limitations of a Financial Statement?
Even though financial statements provide abundant information on a company, they have limitations. Financial statements are open to interpretation, and investors often draw enormously different conclusions about a company’s financial performance.
For instance, some investors may want to stock repurchases but others may prefer to see that money invested in long-term assets. A company’s debt level might be decent for one investor, while another has concerns about the level of debt for the company.
Whenever you analyze financial statements, it is critical to compare multiple periods to gauge if there are any trends. Additionally, you must compare the company’s results to its peers in the same industry.
What Are the Main Items Shown in Financial Statements?
The line items for corporations vary depending on the corporation. They represent different incomes and expenses acquired.
However, the main items shown on financial statements are:
- Cost of goods sold
- Marketable securities
- Short-term debt
- Long-term debt
- Accounts receivable
- Accounts payable
- Cash flows from investing
- Financing activities
What Are the Benefits of Financial Statements?
Financial statements detail how a company operates. It offers insight into how much and how a business generates revenues, what the cost of doing business is, how efficiently it manages its cash, and what its assets and liabilities are. Financial statements display key information on how well or poorly a company manages itself.