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Financial Statements

Updated on April 11, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Financial Statements Definition

Financial statements are written reports created by a company’s management to summarize the business’s financial condition over a certain period (quarter, six-monthly, or yearly). These statements, which comprise the balance sheet, income statement, cash flow statement, and statement of shareholders’ equity, must be prepared by specified and standardized accounting standards to ensure that reporting is consistent.

Financial Statements

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Source: Financial Statements (wallstreetmojo.com)

Financial statements are credentials that ensure investors and other stakeholders have the opportunity to learn about the current financial status of a company before they make investments or other strategic decisions. They can compare every statement prepared to check the actual status of the entities they want to associate with.

Key Takeaways

Financial Statements Explained

Financial statements are records that reflect how a company has performed financially in a fiscal year. These are prepared monthly, quarterly, and annually based on the purposes they are used for. Though companies can have one statement to showcase their financial inflow and outflows, it is difficult for the stakeholders to depend on one record for making major decisions. Thus, they have to develop more than one statement to ensure the readers get a clear picture of their financial status and their performance.

If the financial statements of a company depict improvement in performance, it signifies growth. As a result, investors know that investing in the entity would be a good idea. On the other hand, if the expenses, debt, and costs recorded in the statements are more than the revenue, income, and profits, the company’s performance is doubtful. This, in turn, refrains investors from investing in those entities.

Financial Statements Video Explanation

 

Elements

The preparation of financial statements includes specifications regarding the transactions made, be it revenue generated or expenses incurred. These details are listed under different categories, which constitute the elements or components of the financial statements. Some of them are:

  • Assets
  • Liabilities
  • Net assets (equity)
  • Revenues
  • Expenses

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Types

Now, let us look at the types of financial statements below:

#1 – Balance Sheet

The balance sheet is a financial statement that provides a snapshot of the assets, liabilities, and shareholders’ 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

#2 – Income Statement

The income statementThe Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more is the next financial statement everyone should look at. It looks quite different from the balance sheet.

#3 – Cash Flow Statement

The Cash Flow Statement is the third most important statement every investor should look at.

There are three separate statements of a cash flowStatements Of A Cash FlowA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more statement. These statements are cash flow from the operating activities, cash flow from investing activities, and cash flow from finance activities.

#4 – Statement of Changes in Shareholders Equity

Statement of Changes in Shareholders EquityShareholders EquityShareholder’s equity is the residual interest of the shareholders in the company and is calculated as the difference between Assets and Liabilities. The Shareholders' Equity Statement on the balance sheet details the change in the value of shareholder's equity from the beginning to the end of an accounting period.read more is a financial statement that summarizes changes in the shareholder’s equity in a given period.

Examples

Let us consider the following examples to see how the transactions are recorded and how to read them:

Example 1 – Balance Sheet

Let’s look at a balance sheet so that we can understand how it works –

Financial Statements - Balance Sheet

source: Colgate SEC Filings

The above is just a snapshot of how the balance sheet worksHow The Balance Sheet WorksA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more.

The balance sheet sometimes gets quite complex. The accountants need to make sure that every record is properly reported so that the total assetsTotal AssetsTotal Assets is the sum of a company's current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equityread more always equal total liabilities plus shareholders’ equity.

Example 2 – Income Statement

In the income statement, it’s about the revenue and the expenses.

Income

source: Colgate SEC Filings

Example 3 – Cash Flow Statement

Cash Flow

source: Colgate SEC Filings

Example 4 – Shareholders’ Equity Statement

Changes in Shareholders Equity

source: Colgate SEC Filings

Uses

Consolidated financial statements are of great importance. Below are some of the ways in which these statements can be used:

  • No matter which type of financial statement it is, each of them helps assess the financial status and performance of a company based on the elements they individually take into account.
  • Whether these statements are separately considered or taken into account as a consolidated credential, they are used as the major source of information for stakeholders, especially investors, helping them make wise and well-informed decisions.
  • The detailing in the records helps stock traders to decide whether they should invest in the assets of a particular company.
  • The companies use these statements for policy-making, thereby deciding on the company’s taxation and other aspects.

Importance

The analysis of financial statements serves to be helpful for both the management and investors. As stated above, the investors go through the records to understand how the companies are growing and decide whether they should invest in the assets offered for trade in the market.

On the other hand, the management uses the analysis report to make strategic decisions, keeping in mind the growth of the business and its expansion.

Limitations

Though these credentials are a must for record-keeping and further decision-making, there are a few limitations that one must know of:

  • The transaction records in the financial statements are based on a specific period, which may or may not reflect the present financial status of the companies.
  • There are chances of miscalculation, tampering, or fraud in the record-keeping, which makes it difficult for the readers to rely on the details completely.
  • Referring to only one financial statement is never a good idea. Hence, one must analyze the financial statement individually as well as have a look at the consolidated detail to ensure the derivations are better, clearer, and more reliable.

This has been a guide to what are Financial Statements. Here we explain these with examples, their types, elements, uses, importance, and limitations. You may learn more about basic accounting from the following articles –