Financial statements are very essential while making several business decisions. Business owners, managers, and other stakeholders use financial statements to better understand the value and overall health of their company and to guide financial decision-making. The three financial statements; income statement, balance sheet, and cash flow statement, go hand in hand and provide complete information about the company’s financial status.
Table of content:
What are financial statements?
3. Cash flow statement
Financial statements are written reports that summarize the company’s financial performance and business activities during a certain period of time. Financial statements are an accurate picture of the financial affairs of the company. They are prepared by using financial data of the company collected by accountants and financial analysts by using standardized accounting principles. Investors, market analysts, and creditors use financial statements to assess a company’s financial health and profit potential. Financial statements have the goal of providing information about an enterprise’s financial status, performance, and changes in a financial position that may be used by a variety of users to make economic decisions.
The three main financial statements comprise an income statement, balance sheet, and cash flow statement.
Income statement is a financial statement that includes revenues and expenses, as well as the resulting net income or loss over time. It assists you in understanding the company’s financial health along with the balance sheet and cash flow statement. This document is being prepared to identify areas where expenses can be reduced and can generate more income. The income statement is also known as gain loss statements, earnings statements, and statements of financial results.
Single-step income statement: In a single-step income statement only one category of revenue and one category of spending are shown.
The income statement formula under the single-step method is as follow;
Multi-step income statement: The multi-step statement divides expense accounts into more relevant and usable accounts.
The income statement formula under the multi-step method is as follow;
Gross profit= net sale- the cost of goods sold
| Company ‘A’
|Cost of goods sold ($4300)|
|Gross profit $495,700|
|Printing and stationary $2300|
|Total operating expense ($15,800)|
|Operating income $479,300|
|Total non-operating income $9400|
|Net profit before tax $488,700|
|Net profit $488,300|
The balance sheet provides a snapshot of a company’s financial status at any particular time. It is a document or report that lists a company’s assets, liabilities, and shareholder equity. The balance sheet also provides a broad picture of the performance of the company at a time, the company’s performance in the past, and the expected performance of a company in the future.
An accounting equation is a basis for the preparation of a balance sheet ;
The assets of a company should always equal the sum total of liabilities and shareholder’s equity. A balance sheet is considered to be incorrect if the above equation is not balanced. In that case, the errors in a balance sheet are located and are corrected.
Assets are resources and goods owned by a company that has value and can be converted into cash. Assets include all the cash owned by a company, all physical property (vehicles, plants, etc), and abstract things that have a value (trademark and patent).
Assets are further classified into current assets and non-current assets.
A company’s current assets are typically those that it plans to convert into cash or consume within a year. The most common current assets are as follow;
Non-current assets can generate long-term financial gain and provide insight into the company’s operating performance. These are the assets that a company didn’t expect to convert into the cash in short term. They have a maturity period of more than one year. Non-current assets include;
A liability is anything owed to another company or person by a company or organization. Liabilities include bills it has to pay, utility payments, debt payments, taxes, rents, etc. Obligations to provide goods or services to customers in the future also fall under the category of liabilities. Liabilities are classified into current liabilities and long-term liabilities.
Current Liabilities are obligations owed by the company that must be paid within a specific accounting period, which is usually one year.
Current liabilities include;
Long-term liabilities are obligations that aren’t expected to be settled within a year.
The word shareholder equity refers to a company’s net worth or the entire amount that would be returned to its shareholders if it were liquidated after all obligations were paid. The difference between Assets and Liabilities is used to compute shareholder equity, which is the shareholders’ residual interest in the company.
The table below is a balance sheet of a fictional company. In the below example as you can see there are three sections of the balance sheet (assets, liabilities, and stockholder’s equity). Assets are at the top of the balance sheet followed by liabilities and stockholder’s equity. The value of total assets is $668,000 which equals the sum of liabilities and stockholders which means that this balance sheet is based on the balance sheet formula.
|Cash and cash equivalent $3,000|
|Short-term investments $15,000|
|Accounts receivable-net $35,000|
|Other receivable $2000|
|Prepaid expenses $1000|
|Total current assets $89,000|
|Property, plant & equipment-net|
|Land improvements $8000|
|Total property, plant & equipment $249,000|
|Other assets including intangible assets $300,000|
|Total Assets $668,000|
|Short-term loans payables $17,000|
|Current portion of long-term debt $69,000|
|Account payables $30,000|
|Income tax payables $26,000|
|Other accrued liabilities $5,000|
|Deferred revenues $30,000|
|Total current liabilities $177,000|
|Notes payable $15000|
|Bonds payable $11,500|
|Deferred income taxes $114,500|
|Total long-term liabilities $141,000|
|Total liabilities $318000|
|Common stock $185, 000|
|Retained earning $250,000|
|Accum other comprehensive income $15,000|
|Less: treasury stock ($100.000)|
|Total stockholder’s equity $350,000|
|Total liabilities & stockholder’s equity $668,000|
A cash flow statement is one of the important financial statements that show how much money enters and exits your business over a specific time period or during an accounting period. It provides us with information about the cash you have on hand for a given period. While income statements also show us how much money you’ve spent and earned, however, they don’t always tell you how much cash you have on hand at any given time. The cash flow statement provides insight into the various areas in which a business used or received cash; it is an important financial statement when valuing a company and understanding how it operates.
To get visualised information about cash flow statements take a look at the example of the cash flow statement of a fictional company.
Statement of Cash Flow
CASH AND CASH EQUIVALENTS, BEGINNING OF THE YEAR $6500
Net income $4500
Additions to cash
Increase in Account Payables $6500
Subtraction from Cash
Increase in Account Receivables ($5,000)
Net Cash from Operating Activities $6,500
|FINANCING ACTIVITIES n/a|
|CASH FLOW FOR MONTH DEC 31, 2021 $9,500|
The above cash flow statement shows variations in cash for a reporting period that ended on December 31, 2021. The opening balance of cash and cash equivalents was approximately $6500, as you’ll notice at the top of the statement.
During the Accounting period, operating activities generated a total of $6500. In investing activities no cash is spent on debt and equity financing activities. At the bottom of the cash flow statement, the final balance of cash and cash equivalents at the end of the year is 9500.
The cash flow statement comprises three statements that show us different ways cash can enter or leave the business.
Cash flow from operating activities is money earned or spent in the course of regular business activity. These activities may include purchasing and selling inventory and supplies, as well as paying employees’ salaries. Other types of inflows and outflows, such as investments, debts, and dividends, are excluded.
Cash flow from investing activities is the amount of money earned or spent on investments made by your company, such as purchasing equipment or investing in other businesses. Cash spent on property, plant, and equipment is also included in this section. This is the section where analysts look for changes in capital expenditures (Capex).
Cash flow from financing activities is cash earned or spent while financing your business with loans, lines of credit, or shareholder’s equity. It is a measure of cash flow between a company, its owners, and its creditors, and it is typically derived from debt or equity. The cash flows from the financing section are used by analysts to determine how much money the company has paid out.
Each financial statement has its own purpose and provides specific information, but together they are the most powerful tool and provide all the financial information.