Financial Statements

What are Financial Statements?

Every investor, every trader, and every finance student or professional needs to know what financial statements are.

Financial statements are the accurate picture of the financial affairs of a company in a given year. The financial statements are prepared by using the financial data collected by the accountants or the financial analysts of the company. These financial statements need to be reported by following prescribed and standardized accounting principles so that the reporting has harmony at all levels.

4 Types of Financial Statements

There are four types of financial statements. The first one is the balances sheet that equates assets and liabilities. The second one is the income statement that takes into account the revenue and the expenses and matches them. The third one is the cash flow statement that looks at the cash transactions and non-cash transactions and finds out about the cash inflow and cash outflow. The last one that’s not usually talked about is the explanatory note/s that covers all the minute details about the inventory method used or how the company has calculated its owner’s equity etc.

Financial Statements Examples

Now, let’s look at each of the financial statements examples with a practical example.

#1 – Balance Sheet

The balance sheet is a financial statement 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.

• 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 the summary of changes in the shareholders 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 company keeps after paying the dividend from net income.
• Treasury shares is 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 company’s sources and uses of funds.
• Income Statement provides an understanding of the revenues and the expesnes of the business.
• Cash flows, on the other hand, tracks the movement of cash in the business.
• Statement of Changes in Shareholders equity provides the 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.

Recommended Articles

This has been a guide to what are financial statements. Here we discuss the 4 types of financial statements – balance sheeet, 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 –

• Statement of Comprehensive Income
• What is the Accounting Cycle?
• Learn Basic Accounting in Less than 1 Hour!
• Mark to Market Accounting
• Conservatism Principle of Accounting