What are the Components of Financial Statements?
The components of Financial Statements are the building blocks that together form the Financial Statements and helps in understanding the financial health of the business. and consist of Income Statement, Balance Sheet, Cash Flow Statement and Shareholders Equity Statement. Each component serves a purpose and helps in understanding the financial affairs of the business in a summarized fashion.
Top 4 Components of Financial Statements
The four components are discussed below:
#1 – Balance Sheet
Balance Sheet reports the financial position of the business at a particular point of time. It is also known as the Statement of Financial Position or Statement of Financial Condition or Position Statement.
It shows the Assets owned by the business on one side and sources of funds used by the business to own such assets in the form of Capital contribution and liabilities incurred by the business on the other side. In nutshell, Balance Sheet shows how the money has been made available to the business of the company and how the money is employed by the company.
Balance Sheet basically Consists of 3 Elements:
These are the resources controlled by the business. They can take the form of Tangible Asset or Intangible Assets and can also be classified on the basis of Current Assets (which are to be converted into cash within a year) and Non-Current Assets (which are not converted into cash within a year).
These are the amounts owed to lenders and other creditors. Liabilities are further classified into Current Liabilities such as Bills Payable, Creditors, etc (which are payable within a year) and Non-Current Liabilities such as Term Loans, Debentures, etc. (which are not payable within a year).
Also known as Capital Contribution by the Owner. It shows the residual interest in the Net Assets of an entity that remains after deducting its liabilities. It is also a sign of promoter’s skin in the game (i.e. business).
For each transaction in the Balance Sheet, the fundamental accounting equation holds:
#2 – Income Statement
The Income Statement reports the financial performance of the business over a period of time and comprise of Revenue (which comprise of all cash inflows from manufacturing of goods and rendering of services), Expenses (which comprise of all cash outflows incurred in the manufacturing of goods and rendering of services) and also comprise of all gains and losses which are not attributable in the ordinary course of business. Excess of Revenues over Expenses result in Profit and vice versa resulting in Loss for the business during that period.
Under IFRS, Income Statement also comprises of Other Comprehensive Income which comprise of all changes in Equity except for shareholder transactions and as such can be presented together as a single statement. However as per US GAAP guidelines Statement of Comprehensive Income forms part of Statement of Changes in Equity.
#3 – Statement of Changes in Equity
This statement is one of the components of the financial statement which reports the amount and sources of changes in Equity Shareholders Investment in the business over a period of time. It summarizes the changes in the capital and reserves attributable to Equity holders of the company over the accounting period and accordingly all the increase and decrease during the year when adjusted with the Beginning Balance results in Ending Balance.
The statement includes transactions with shareholders and reconciles the beginning and ending balance of each equity account, including capital stock, additional paid-in capital, retained earnings, and accumulated other comprehensive income. The statement basically shows how the composition of equity (share capital, other reserves and Retained Earnings) has changed over the year.
#4 – Cash Flow Statement
This statement shows the changes in the financial position of the business on from the perspective of movement of cash into and from the business. The basic rationale behind the preparation of a cash flow statement is to supplement the Income Statement and Statement of Financial Position as these statements don’t provide sufficient insight into movements in cash balances.
Cash flow statement bridges that gap and helps various stakeholders of the business to understand the sources of cash and utilization of cash. Basically, there are three sections to the cash flow statement namely:
- Cash Flow from Operating Activities – It starts from Operating Profit and reconciles operating profit to cash.
- Cash Flow from Investing Activities – It comprises of all acquisition/purchase of long term assets and disposal/sale of long term Assets and other investment which are not included in cash equivalent. It also includes receipts of interest and dividend from investments.
- Cash Flow from Financing Activities – It accounts for changes in equity capital and borrowings and comprises of payment of dividend to the shareholders of the company, cash flows arising from the repayment of loans and fresh borrowing and issue of shares.
Each component of the Financial Statements serves a special and useful purpose and helps various stakeholders understand the financial health of the business in a more simplified manner and make better decisions either an investor or a lender and so on.
- Balance sheet statement has its utility lies in showing the position of the business on a particular date.
- Income Statement, on the other hand, shows the performance of the business during the year and provide a more granular view thereby complementing Balance Sheet.
- Statement of changes in Equity shows how equity capital changed during the accounting period and helps stakeholders understand the Owners perspective.
- Cash flow Statement provides information about the company’s cash receipts and cash payments during an accounting period which provides meaningful information to analyze the liquidity, solvency and financial flexibility of the business.
This has been a guide to Components of Financial Statements. Here we discuss the top 4 components including income statement, balance sheet, cash flows, statement of changes in equity with its format and explanation. You may learn more about accounting from the following articles –