Financial statements provide a picture of the performance, financial position and cash flows of a business. They represent a formal record of the financial activities of an entity. These reports quantify the financial strength, performance and liquidity of a company and reflect the financial effects of business transactions and events on the entity. These documents are used by the investment community, lenders, creditors and management to evaluate an entity. The four main types of financial statements are the income statement, statement of financial position, statement of cash flows and statement of changes in equity.
- Income Statement
The income statement, also known as the profit and loss statement, reports a company’s financial performance in terms of net profit or loss earned over a specific period of time. It consists of two basic elements, income and expenses. Income refers to what the business has earned over the period; such as sales revenue, dividend income etc. and expenses are the costs incurred by the business such as depreciation, rent charges, salaries, wages etc. This statement begins with sales, and then deducts cost of sales to arrive at gross profit. All expenses incurred are then subtracted from the gross profit to determine the net profit or loss. This is considered the most important financial statement since it describes performance.
- Statement of Financial Position
The statement of financial position, also known as the balance sheet, represents the financial position of an entity at a given date and comprises of three basic elements, assets, liabilities and equity. Assets refer to something that the business owns or controls, for example, cash, inventory, plant and machinery etc. Liabilities are what the business owes to someone, for example, creditors, bank loans etc. Assets and liabilities are stated in the order of liquidity, so that the most liquid items come first. Lastly, equity is what the business owes to its owners and represents the amount of capital that remains in the business after the assets are used to pay off the liabilities. Therefore, equity is the difference between assets and liabilities. This is a very important document and is included in most issuances of the financial statements.
- Statement of Cash Flows
The cash flow statement represents the movement in cash and bank and reveals the cash inflows and outflows experienced by an organization over a specific period. The movement in cash flows is classified into operating, investing and financial activities. Operating activities represent the cash flow from the primary activities of a business, investing activities represent the cash flow from the purchase and sale of assets and financing activities represent the cash flow generated or spent on raising share capital and repaying debt while also including the payment of interest and dividends. This document can be hard to assemble and is only issued to outside parties.
- Statement of Changes in Equity
Statement of changes in equity, also known as the statement of retained earnings, represents the movement in owner’s equity over a specific period and is derived from the net profit or loss reported in the income statement, share capital issued or repaid during the period, dividend payments and gains or losses recognized in equity such as revaluation reserves. This document is not usually included when the financial statements are issued internally, as the information in it is not overly useful to the management team.
All these financial statements are closely related to each other and cannot be isolated from one another. For example, the statement of financial position cannot be made without the preparation of the income statement.