Financial statements
Financial statements are formal
records that outline the financial activities and position of a business,
organization, or individual. They provide essential information for
stakeholders, including investors, creditors, management, and regulators, to
assess the financial health and performance of an entity. The primary financial
statements include:
1.
Income Statement (Profit and Loss Statement)
- Purpose:
Shows the company’s revenues and expenses over a specific period,
ultimately determining the net profit or loss.
- Key Components:
- Revenue/Sales:
Total income generated from goods or services sold.
- Cost of Goods Sold (COGS): Direct costs attributable to the production of goods
sold.
- Gross Profit:
Revenue minus COGS.
- Operating Expenses: Expenses incurred in the normal course of business
(e.g., salaries, rent, utilities).
- Operating Income: Gross profit minus operating expenses.
- Net Income:
Total profit or loss after all expenses, taxes, and costs have been
deducted from total revenue.
2.
Balance Sheet (Statement of Financial Position)
- Purpose:
Provides a snapshot of a company’s assets, liabilities, and equity at a
specific point in time.
- Key Components:
- Assets:
Resources owned by the company (e.g., cash, inventory, property,
equipment).
- Current Assets: Expected to be converted
into cash or used within one year (e.g., cash, accounts receivable,
inventory).
- Non-Current Assets: Long-term investments and
assets (e.g., property, plant, and equipment).
- Liabilities:
Obligations owed to creditors (e.g., loans, accounts payable).
- Current Liabilities: Due within one year (e.g.,
accounts payable, short-term loans).
- Non-Current Liabilities: Due after one year (e.g.,
long-term debt).
- Equity:
The residual interest in the assets after deducting liabilities,
representing the owners’ share (e.g., common stock, retained earnings).
3.
Cash Flow Statement
- Purpose:
Shows the inflows and outflows of cash over a specific period,
highlighting how cash is generated and used in operating, investing, and
financing activities.
- Key Components:
- Operating Activities: Cash flows from day-to-day business operations
(e.g., receipts from sales, payments to suppliers).
- Investing Activities: Cash flows related to the acquisition and disposal
of long-term assets (e.g., purchase/sale of equipment).
- Financing Activities: Cash flows from transactions with the company's
owners and creditors (e.g., issuing stock, borrowing funds, repaying
debt).
4.
Statement of Changes in Equity (Statement of Retained Earnings)
- Purpose:
Details changes in equity accounts over a specific period, including
retained earnings, common stock, and other equity components.
- Key Components:
- Beginning Equity: Equity at the start of the period.
- Net Income:
Added to retained earnings from the income statement.
- Dividends:
Amounts distributed to shareholders, subtracted from retained earnings.
- Ending Equity:
Equity at the end of the period.
Importance
of Financial Statements
- Decision-Making:
Help management, investors, and creditors make informed decisions
regarding resource allocation, investments, and credit.
- Performance Evaluation: Assess the profitability, efficiency, and financial
stability of a business.
- Compliance:
Provide necessary information for regulatory compliance and audits.
- Transparency:
Foster transparency and trust among stakeholders by providing a clear view
of the company's financial position and performance.
Financial statements are typically
prepared periodically (e.g., quarterly, annually) and are essential for
understanding a company's financial health and guiding strategic decisions.