Businesses communicate their financial performance or financial health through financial statements. Financial statements are a part of ‘finance basics’, being the lifeblood of any organisation or company, revealing its financial performance and position over a period of time. They provide valuable insights into the company's profitability, liquidity, solvency, and cash flow, all of which are essential to make informed decisions.
The company's ongoing operations and transactions are reflected in the financial statements, which are transaction-driven documents that change over time. They are made to give creditors, investors, and other interested parties pertinent details about a company's financial performance and position so they can decide whether to lend money to, invest in, or conduct business with the company.
Financial statements are crucial in helping businesses stay competitive and adaptable in today's quick-changing business environment. Companies can spot potential risks and opportunities, decide on a course for the future, and manage their operations by closely monitoring their financial statements.
Understanding financial statements is crucial for making data-driven decisions and achieving financial goals. Let us explore the finance basics and delve into the world of financial statements together.
Definition of Financial Statements
Financial statements are extensive reports that give specific information about the position and performance of a company's finances. These reports are crucial tools for creditors, investors, and other stakeholders who need to evaluate a company's financial standing.
A balance sheet, an income statement, and a statement of cash flows are some of the essential parts of a financial statement. A company's assets, liabilities, and equity are summarised on the balance sheet, while its revenues, outlays, and net income for a specific time period are shown on the income statement. A company's operating, investing, and financing activities, as well as its cash inflows and outflows over the course of the same period, are all covered by the statement of cash flows.
These elements of a financial statement, when taken as a whole, give a complete picture of the financial performance and health of a company, including its profitability, liquidity, solvency, and cash flow. Investors can use financial statement analysis to decide whether to invest in a company or not, and creditors can use it to assess a company's creditworthiness and default risk.
Types of Financial Statements and Examples
As discussed above, there are three primary types of financial statements that businesses use to communicate their financial performance to external stakeholders. Let us understand more about each of these financial statements with examples:
Balance Sheet
The financial position of a company is shown on a balance sheet at a particular point in time, usually the conclusion of a reporting period, such as a quarter or a year. It gives a clear picture of what a company owns and owes by listing its assets, liabilities, and equity.
Assets = Liabilities + Equity (Formula for a balance sheet).
Examples of items in balance sheets are:
Assets: Cash, accounts receivable, inventory, property, plant and equipment, investments, etc.
Liabilities: Accounts payable, loans payable, accrued expenses, deferred revenue, etc.
Equity: Common stock, retained earnings, treasury stock, etc.
Income Statement
A company's revenues, expenses, gains, and losses over a given period, such as a quarter or a year, are detailed in an income statement, also known as a profit and loss statement. It displays the company's earnings, expenses, and net income for that time frame.
Revenues - Expenses = Net Income (Formula for calculating income statements).
Examples of items in income statements are:
Revenues: Sales revenue, service revenue, rental income, interest income, etc.
Expenses: Cost of goods sold, operating expenses, depreciation, interest expense, etc.
Gains and losses: Gain on sale of assets, loss on write-down of assets, etc.
Statement of Cash Flows
An organisation's cash inflows and outflows for a given time period, such as a quarter or a year, are detailed in a statement of cash flows. It provides information about a company's liquidity and cash flow position by displaying how much cash a company generated from its operations, investing, and financing activities during that time.
Examples of items in cash flow statements are:
Operating activities: Cash received from customers, cash paid for inventory, cash paid for salaries and wages, etc.
Investing activities: Cash received from the sale of investments, cash paid for the purchase of property and equipment, cash received from the sale of property and equipment, etc.
Financing activities: Cash received from the issuance of common stock, cash paid for dividends, cash received from the issuance of debt, cash paid for the repayment of debt, etc.
Conclusion
Financial statements are essential documents that provide detailed information about a company's financial health and performance. They serve as a critical tool for making informed investment and lending decisions, and they provide transparency into a company's financial position, allowing stakeholders to assess its potential for long-term success.
General Management program such as the 21st General Management Programme by IIM Ahmedabad and Imarticus Learning can help you acquire a solid foundation in finance.
