In bookkeeping and accounting, a financial statement is a formal, structured report that summarizes the financial activities and financial position of a business or organization over a specific period of time. Financial statements provide valuable insights into a company’s financial performance, liquidity, profitability, and overall financial health. These statements are essential tools for financial analysis, decision-making, and communication with stakeholders, including investors, creditors, regulators, and management.
The three primary financial statements typically prepared by a business are:
- Income Statement (Profit and Loss Statement): The income statement provides a summary of a company’s revenues, expenses, gains, and losses over a specific period, often a fiscal quarter or year. It calculates the net income (profit or loss) by subtracting total expenses from total revenues. Key components of the income statement include:
- Revenues (Sales or Sales Revenue): The total amount of money earned from selling goods or providing services during the period.
- Expenses: The costs incurred in generating revenue, such as operating expenses, cost of goods sold (COGS), depreciation, interest, and taxes.
- Net Income (Profit or Loss): The amount of money the company earned (or lost) after all expenses are subtracted from revenues.
- Balance Sheet (Statement of Financial Position): The balance sheet presents the company’s financial position at a specific point in time, typically at the end of a fiscal quarter or year. It provides a snapshot of the company’s assets, liabilities, and shareholders’ equity. The balance sheet adheres to the fundamental accounting equation:
- Assets = Liabilities + Shareholders’ Equity Key components of the balance sheet include:
- Assets: Resources owned or controlled by the company, including cash, accounts receivable, inventory, property, plant, equipment, and investments.
- Liabilities: Obligations or debts owed by the company to external parties, such as accounts payable, loans, and accrued expenses.
- Shareholders’ Equity: The residual interest in the assets of the company after deducting liabilities. It includes common stock, retained earnings, and additional paid-in capital.
- Cash Flow Statement (Statement of Cash Flows): The cash flow statement reports the cash inflows and outflows resulting from the company’s operating, investing, and financing activities during a specific period. It provides insights into the company’s cash liquidity and the sources and uses of cash. The cash flow statement is typically divided into three sections:
- Operating Activities: Cash flows from the company’s core business operations, including receipts from customers and payments to suppliers, employees, and other operating expenses.
- Investing Activities: Cash flows related to the acquisition and sale of long-term assets, such as property, plant, equipment, and investments.
- Financing Activities: Cash flows from raising capital (e.g., issuing stock or taking out loans) and the repayment of debt, as well as dividend payments to shareholders.
Financial statements are prepared in accordance with generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) to ensure consistency, comparability, and accuracy of financial information. They are typically audited by external auditors to provide assurance on their reliability and compliance with accounting standards.
These financial statements, along with accompanying notes and management’s analysis (Management’s Discussion and Analysis or MD&A), are collectively used by stakeholders for investment decisions, credit evaluations, regulatory compliance, financial analysis, and assessing the financial health and performance of a business.
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