What are the Financial Statements?
Financial statements are written reports prepared by company’s management to present its financial affairs in a given period (quarter, six monthly or yearly). These statements include Balance Sheet, Income Statement Cash Flows and Shareholders equity statement and are to prepared following prescribed and standardized accounting principles so that the reporting has harmony at all levels.
Financial Statement Types
Now, let’s look at each of the financial statements types along with a practical example.
#1 – Balance Sheet
The balance sheet is a financial statement that provides a snapshot of the assets, the liabilities, and the shareholder’s equity. Many companies use the shareholders’ equity as a separate financial statement. But usually, it comes with the balance sheet.
The equation that you need to remember when you prepare a balance sheet is this –
Assets = Liabilities + Shareholders Equity
Let’s look at a balance sheet so that we can understand how it works –
source: Colgate SEC Filings
The above is just a snapshot of how the balance sheet works.
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- Under the current assets, you can consider cash, accounts receivable, rent prepaid, etc. Under the non-current assets, we can put equipment, plant, building, etc.
- The idea is to follow a sequence from more liquid to less liquid.
- At the same time, on the other hand, you can consider notes payable, accounts payable, income tax payable, outstanding salaries, etc. As a long-term/non-current liability, you can consider long-term debt.
The balance sheet sometimes gets quite complex, and the accountants need to make sure that every record is properly reported so that the total assets always equal total liabilities plus shareholders’ equity.
#2 – Income Statement
The income statement is the next financial statement everyone should look at. It looks quite different than the balance sheet. In the income statement, it’s about the revenue and the expenses.
source: Colgate SEC Filings
- Well, it starts with the gross sales or revenue. Then we deduct any sales return or sales discount from the gross sales to get the net sales. This net sale is what we use for ratio analysis.
- From net sales, we deduct the costs of goods sold, and we get the gross profit.
- From gross profit, we deduct the operating expenses like the expenses required for daily administrative expenses. By deducting the operating expenses, we get the EBIT, meaning the earnings before interest and taxes.
- From EBIT, we deduct the interest charges paid or add interest received (if any), and we get EBT, meaning earnings before taxes.
- From EBT, we deduct the income taxes for the period, and we get the Net Income, meaning profit after tax.
#3 – Cash Flow Statement
Cash Flow Statement is the third most important statement every investor should look at.
There are three separate statements of a cash flow statement. These statements are cash flow from the operating activities, cash flow from investing activities, and cash flow from finance activities.
source: Colgate SEC Filings
- Cash Flow from Operations is the cash generated from the core operations of the business.
- Cash Flow from Investing Activities relates to the cash inflows and outflows related to investment in the company like buying of property, plant, and equipment or other investments.
- Cash Flow from Financing Activities relates to the cash inflows or outflows related to debt or equity of the company. It includes raising of debt or equity, loan repayments, buyback of shares, and more.
#4 – Statement of Changes in Shareholders Equity
Statement of Changes in Shareholders Equity is a financial statement that provides a summary of changes in the shareholder’s equity in a given period.
source: Colgate SEC Filings
- Common Stock is the first and most important component of shareholders’ equity. Common stockholders are the owners of the company.
- Additional Paid in Capital means when the company receives a premium on the shares.
- Retained earnings or losses are accumulated from the previous period. In simple terms, retained earnings are the amount the company keeps after paying the dividend from net income.
- Treasury shares are the sum total of all the common shares that have been purchased back by the company.
- Accumulated Other comprehensive income contains unrealized gains/losses that do not flow through the income statement.
Conclusion
Financial Statements provide a financial snapshot of the company’s performance over the years.
- Balance Sheet provides the details of the company’s sources and uses of funds.
- Income Statement provides an understanding of the revenues and the expenses of the business.
- Cash flows, on the other hand, tracks the movement of cash in the business.
- Statement of Changes in Shareholders’ equity provides a summary of shareholders’ accounts for a given period.
Besides these four types of financial statements discussed above, it is also important that you look at the explanatory notes to the accounts. These notes provide a detailed explanation of the line items.
Financial Statements Video
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This has been a guide to what are financial statements and its definition. Here we provide an overview of financial statements – balance sheet, income statement, cash flows, and statement of changes in shareholders equity along with practical examples. You may learn more about basic accounting from the following articles –
