Every day, a business carries out thousands of financial transactions that act either as revenue or as costs to the company. The various costs that are incurred and the revenues that are collected need to be recorded and kept track of so that the business can analyze and modify its activities. Financial statements are records of all financial activities of a business. Which can use by the business, accountants and government agencies to monitor the business’s financial performance and its transparency.
Financial statement analysis is important for many different reasons. For instance, it allows a business to track its financial trends over a period. It also allows government transparency agencies to ensure that the business is following the required accounting standards. And allows taxation agencies to have a clear understanding of the firm’s revenues and expenses.
It also allows the business itself to analyze its performance within a certain period and compare it with its competitors. Most importantly, it gives an idea to investors about the company’s financial performance. Which helps them to decide whether to invest in a company.
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The Four Types of Financial Statements: A Summary
Primarily, financial statements can be of four types:
The Income Statement, also called the Profit and Loss Statement, analyzes a firm’s revenues and expenses to calculate the net profit or loss of the company. It shows how a company manages its finances and produces a net income. This allows the managers and the stakeholders to make financial decisions that affect the company.
An income statement is often used to analyze finances over a period of time. It mainly comprises of two segments. The Revenue and the Expenses.
Revenue represents what a business has earned over a certain period, through the sale of its products and services. It consists of the various cash inflows into a business. Usually, it is calculated as the total sales minus any discounts or returns that have been offered by the business.
Expenses consist of the cash outflows from the business and the various liabilities that occur. It includes the direct costs of producing a good or service such as the cost of raw materials or labor required. It also includes the cost of marketing, advertising, storage, utility bills, legal fees, insurance, rent, and other administrative expenses. Expenses also consist of depreciation. Which represents the decrease in the price of a fixed asset over time.
By deducting all the expenses from the income of the business. The net profit or loss of a business can be calculated. Revenue greater than expenses generally indicates a net profit. Whereas, if expenses are larger than revenue, the business is at a loss.
Statement of Financial Position
A statement of financial position or balance sheet indicates the entire summary of all the financial aspects of an individual or business at a particular moment. Unlike the income statement, it is not calculated over a period but rather at a fixed moment in time. A balance sheet consists of 3 major parts: assets, liabilities, and equity.
Assets are anything that is owned by the company that is assigned a value. It consists of physical property such as land, furniture, vehicles, and equipment in addition to monetary concepts such as cash, bank balance, and debt. It also consists of abstract concepts such as patents and trademarks which are of value to the company.
Liabilities, on the other hand, are anything of assigned value that a company owes. It includes obligations such as money owed to the bank or other business, expenses owed such as rent and utility, and taxes owed to the government. Liabilities also include goods or services that a company owes to its customers after receiving the payment.
Equity also called the capital or net worth is the monetary value of the company due to all the assets minus the liabilities. As the name suggests, this is the worth of the company to investors or shareholders.
Statement of Changes in Equity
A statement of changes in equity or statement of equity, as the name suggests, portrays the changes in the equity of a company over a certain period. It shows investors and shareholders their gain and the changes in capital from one accounting period to another.
A statement of equity shows the net profit or loss, the capital invested, the dividends among investors, and accounting errors within an accounting period. The statement of change in equity is important to investors as it allows them to see a clear picture of the returns gained or losses incurred due to their investments.
Statement of Cash Flows
A statement of cash flows, or a cash flow statement. It is a financial statement that breaks down a business’s financial activities based on information from its balance sheet and income statement. It illustrates the various ways through which cash flows in and out of a business. A cash flow statement consists of 3 major components.
Operating Activities represent the cash flow in a company due to its activities. It consists of receptions of loans and interests and also the payment to other businesses and employees.
Investing Activities represent the cash flow due to the sale and purchase of assets such as land to and from other businesses. Loans gave out to suppliers and payments that occur due to mergers and acquisitions made by the company.
Financing Activities refer to the inflow of cash that occur due to investment of banks and shareholders, as well as the outflow of cash due to the payment of dividends to the investors.
In conclusion, each of the financial statements plays a key role in business for an investor or shareholder to make decisions about a company. Whilst the four financial statements can be useful tools in making business decisions. They are not the only indicator of a company’s growth or failure. How an investor uses this data to make a decision is up to him.