What is Financial Statement? An Explanation of Types of the Financial Statements

What is Financial Statement? An Explanation of Types of the Financial Statements

Financial statements are written records that convey the business activities and the financial performance of firms.

Financial statements are reports prepared by a company's management to present the financial performance and position at a point in time

Its objective is to provide information about the financial position, performance, and changes in the financial position of a firm that is useful to a wide range of users in making economic decisions.

Financial Statements Tells

Investors and financial analysts rely on financial data to analyze the performance of a company and make predictions direction of the company's stock price. One of the most important resources of reliable and audited financial data is the annual report, which contains the firm's financial statements.

The financial statements are used by investors, market analysts, and creditors to evaluate a company's financial health and earnings potential. The three major financial statement reports are the balance sheet, income statement, and statement of cash flows.

1. Balance Sheet

The balance sheet provides an overview of assets, liabilities, and stockholders' equity as a snapshot in time. The date at the top of the balance sheet tells you when the snapshot was taken, which is generally the end of the fiscal year.

Assets = Liabilities + Owner’s Equity

Items on a Balance Sheet

• Assets
• Cash and cash equivalents are liquid assets, which may include Treasury bills and certificates of deposit.
• Accounts receivables are the amount of money owed to the company by its customers for the sale of its product and service. And Inventory.
• Liabilities
• Debt including long-term debt: Rent and tax
• Wages payable and Dividends payable
• Shareholders’ Equity
• Shareholders equity is a company's total assets minus its total liabilities. Shareholders' equity represents the amount of money that would be returned to shareholders if all of the assets were liquidated and all of the company's debt was paid off.
• Retained earnings are part of shareholders' equity and are the percentage of net earnings that were not paid to shareholders as dividends.

2. Income Statement

Unlike the balance sheet, the income statement covers a range of time, which is a year for annual financial statements and a quarter for quarterly financial statements. The income statement provides an overview of revenues, expenses, net income, and earnings per share.

Net Income = Revenue−Expenses

An income statement is one of the three important financial statements used for reporting a company's financial performance over a specific accounting period. Also known as the profit and loss statement or the statement of revenue and expense, the income statement primarily focuses on a company’s revenues and expenses during a particular period.

Once expenses are subtracted from revenues, the statement produces a company's profit/loss figure called Net Income or Net Loss.

Types of Revenue

Operating revenue is the revenue earned by selling a company's products or services. The operating revenue for an auto manufacturer would be realized through the production and sale of autos. Operating revenue is generated from the core business activities of a company.

Non-operating revenue is the income earned from non-core business activities. These revenues fall outside the primary function of the business. Some non-operating revenue examples include:

1. Interest earned on cash in the bank
2. Rental income from a property
3. Income from strategic partnerships
4. Income from an advertisement display (Billboards & Sign boards) located on the company's property.

Types of Expenses

Primary expenses are incurred during the process of earning revenue from the primary activity of the business. Expenses include the cost of goods sold (COGS), selling, general and administrative expenses (SG&A), and R&D.

Typical expenses include employee wages, sales commissions, and utilities such as electricity and transportation.

Expenses that are linked to secondary activities include interest paid on loans or debt. Losses from the sale of an asset are also recorded as expenses.

The main purpose of the income statement is to convey details of profitability and the financial results of business activities. However, it can be very effective in showing whether sales or revenue is increasing when compared over multiple periods. Investors can also see how well a company's management is controlling expenses to determine whether a company's efforts in reducing the cost of sales might boost profits over time.

3. Cash Flow Statement

The cash flow statement (CFS) measures how well a company generates cash to pay its debt obligations, fund its operating expenses, and fund investments. The cash flow statement complements the balance sheet and income statement.

It tells investors to understand how a company's operations are running, where its money coming from, and how money is being spent. It contains three sections that report the cash flow for the various activities that a company has used its cash. Those three components of the CFS are;

1. Operating Activities, the operating activities on the CFS include any sources and uses of cash from running the business and selling its products or services. Cash from operations includes any changes made in cash, accounts receivable, depreciation, inventory, and accounts payable. These transactions also include wages, income tax payments, interest payments, rent, and cash receipts from the sale of a product or service.
2. Investing Activities, investing activities include any sources and uses of cash from a company's investments into the long-term future of the company. A purchase or sale of an asset, loans made to vendors or received from customers, or any payments related to a merger or acquisition are included in this category. Also, purchases of fixed assets such as property, plant, and equipment (PPE) are included in this section. In short, changes in equipment, assets, or investments relate to cash from investing.
3. Financing Activities, cash from financing activities includes the sources of cash from investors or banks, as well as the uses of cash paid to shareholders. Financing activities include debt issuance, equity issuance, stock repurchases, loans, dividends paid, and repayments of debt. The cash flow statement reconciles the income statement with the balance sheet in three major business activities.