Financial Statements are written records that represent the activities of a business for a period. They contain information regarding income, expenses, equity, cash flow, assets, and liabilities. Financial statements are prepared by managers of the company and validated by external auditors.
There are 4 types of Financial Statements:
- Income Statement OR, Statement of Profit & Loss
- Statement of Financial Position
- Statement of Cash Flows
- Statement of Changes in Equity
Income Statement
A type of Financial Statement that records an entity’s income and expenses for a given period. Income is money/value that a business receives in exchange for a product or service while expense is a decrease in an entity’s assets.
The income statement contains different types of expenses and incomes. The income sources are added and expenses are deducted from them to arrive at the final figure. The resultant figure could be a profit or loss depending on the performance of the business.
Elements of Income Statement
You would normally see the following types of incomes and expenses in the income statement of a company:
| Income | Expenses |
|---|---|
| Revenue (sales) | Direct Production Costs |
| Income from the sale of Non-Current Assets | Rent Expense |
| Income from investments | Admin Expenses |
| Interest Received | Tax |
| Interest paid | |
| Discretionary Expenses |
These income and expense figures arise from their respective line items. Expenses are deducted from incomes and total Profit/Loss is calculated.
Statement of Financial Position
Statement of Financial Position (SPFP) lists a company’s Assets, Liabilities, and Equity. Assets are items of monetary value that the entity generates or gains from past events. Liability is the opposite and is a company’s obligation, the settlement of which is going to result in an outflow of economic benefits.
Equity simply means, the remaining balance after ALL of a company’s assets are liquidated/sold and obligations/Liabilities fulfilled. It’s an important figure for existing and potential investors and is used in many key financial ratios.
SOFP of a company reflects the company’s assets, liabilities, and equity on a given date. That means, it doesn’t reflect the performance of the entity for a period but is a mere valuation of the company on a specific date in time. You will always see the date of SOFP in the format: ‘Vikram Co. Statement of Financial Position Dec 31, 2020‘.
That would mean, Vikram Co’s assets, liabilities, and equity on 31 Dec 2020. The figures, however, could have been wholly different for the entire year and/or have changed after the financial statement’s date. This is different from the income statement that draws the performance of a company for the whole period/year.
In SOFP, the total assets should always be equal to the sum of liabilities & equity. Why? Let’s say a company is planning to buy machinery, which is an asset, it can either raise capital by taking out a loan (liability) or issuing new shares which would result in an increase in equity!
Elements of Statement of Financial Position
| Element | Description |
|---|---|
| Assets | Resources owned by a company, including cash, investments, inventory, and property. |
| Liabilities | Amounts owed by a company, including loans, accounts payable, and taxes. |
| Equity | The residual interest in the assets of a company after deducting liabilities is also referred to as shareholder’s equity. |
Statement of Cash Flows
Cash is considered the most important element for a company’s success. A good profit figure or increased non-current assets might mean nothing if the company doesn’t have cash. Cash to pay its suppliers and lenders, and meet day-to-day expenses.
One of the most important financial statements for any business is the statement of cash flows. This document provides a detailed analysis of a company’s cash inflows and outflows, giving stakeholders a clear understanding of the business’s financial health.
What is a Statement of Cash Flows?
A statement of cash flows, also known as the cash flow statement, is a financial document that shows the cash generated and used by a company during a specific period of time. It is typically prepared on a quarterly or annual basis and is used in conjunction with the balance sheet and income statement to give a complete picture of a company’s financial situation.
The statement of cash flows is divided into three sections: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. These sections provide information on how a company generates and uses cash, including cash received from customers, cash paid to suppliers and employees, and cash used for investments and financing.
Cash Flows from Operating Activities
The first section of the statement of cash flows, cash flows from operating activities, provides information on a company’s cash inflows and outflows from its normal business operations. This includes cash received from customers, cash paid to suppliers and employees, and other cash transactions related to the day-to-day operations of the business.
It is important to note that this section does not include cash transactions related to investing or financing activities. Instead, it focuses solely on the cash generated and used by the business in its normal operations. This information can be used to determine the company’s ability to generate cash and meet its operating expenses.
Cash Flows from Investing Activities
The second section of the statement of cash flows, cash flows from investing activities, provides information on a company’s cash transactions related to investments and acquisitions. This includes cash used to purchase property, plant, and equipment, as well as cash received from the sale of investments or assets.
This section can be used to determine the company’s ability to generate cash from its investments and acquisitions. A company that generates a large amount of cash from its investing activities may be in a better financial position than a company that uses a significant amount of cash for these activities.
Cash Flows from Financing Activities
The third and final section of the statement of cash flows, cash flows from financing activities, provides information on a company’s cash transactions related to financing and borrowing. This includes cash received from issuing stock or bonds, cash used to pay dividends, and cash used to pay off debt.
This section can be used to determine the company’s ability to raise capital and manage its debt. A company that generates a large amount of cash from financing activities may be in a better financial position than a company that uses a significant amount of cash for these activities.
Analyzing Your Statement of Cash Flows
Once you have a clear understanding of the three sections of the statement of cash flows, it is important to analyze the information to make informed decisions about the future of your business. This includes looking at the overall cash balance, as well as the cash generated and used in each section.
It is also important to compare the statement of cash flows to previous periods and to industry averages to determine if the business is improving or declining in its financial health. Additionally, it is important to pay close attention to trends and patterns in the data to identify potential problems or opportunities for growth.
Statement Of Changes In Equity
The statement of changes in equity, also known as the statement of retained earnings, is a financial statement that provides a detailed analysis of the changes in a company’s equity over a specific period of time. This statement is typically used to track changes in a company’s net income, dividends, and other transactions that impact its equity.
Equity, also known as shareholders’ equity or stockholders’ equity, refers to the portion of a company’s assets that are owned by its shareholders. This includes common stock, preferred stock, and retained earnings. Equity is important because it represents the portion of a company’s assets that are available to pay dividends to shareholders and to fund future growth.
Components of the Statement of Changes in Equity
The statement of changes in equity typically includes several key components, including:
- Net Income: This is the amount of money a company earns after all expenses have been paid. It is a key component of the statement of changes in equity because it can have a significant impact on a company’s equity.
- Dividends: This is the amount of money a company pays out to shareholders as a return on their investment. Dividends can also have a significant impact on a company’s equity, as they represent a reduction in the company’s retained earnings.
- Other Comprehensive Income: This includes items such as foreign currency translation adjustments and gains and losses on investments that are not included in net income. These items can also impact a company’s equity.
- Transactions with Owners: This includes transactions such as the issuance of new shares or the repurchase of existing shares. These transactions can also impact a company’s equity.
Importance of the Statement of Changes in Equity
The statement of changes in equity is an important financial statement for several reasons. Firstly, it provides insight into a company’s financial health by showing how its net income and dividends are impacting its equity. Additionally, the statement of changes in equity can be used to evaluate a company’s ability to pay dividends and fund future growth.
Furthermore, the statement of changes in equity can also be used to identify any potential red flags in a company’s financials. For example, a company that consistently pays out more in dividends than it earns in net income may be at risk of financial trouble.
