Financial Statement

Financial Statements represent a formal record of the financial activities of an entity.

These are written reports that quantify the financial strength, performance and
liquidity of a company. Financial Statements reflect the financial effects of business
transactions and events on the entity.

Four Types of Financial Statements

The four main types of financial statements are:

Statement of Financial Position

Statement of Financial Position, also known as the Balance Sheet, presents the
financial position of an entity at a given date. It is comprised of the following three
elements:
Assets: Something a business owns or controls (e.g. cash, inventory, plant and
machinery, etc)
Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)
Equity: What the business owes to its owners. This represents the amount of capital
that remains in the business after its assets are used to pay off its outstanding
liabilities. Equity therefore represents the difference between the assets and
liabilities.
View detailed explanation and Example of Statement of Financial Position

Income Statement
Income Statement, also known as the Profit and Loss Statement, reports the
company's financial performance in terms of net profit or loss over a specified
period. Income Statement is composed of the following two elements:
Income: What the business has earned over a period (e.g. sales revenue, dividend
income, etc)
Expense: The cost incurred by the business over a period (e.g. salaries and
wages, depreciation, rental charges, etc)
Net profit or loss is arrived by deducting expenses from income.
View detailed explanation and Example of Income Statement

Cash Flow Statement

Cash Flow Statement, presents the movement in cash and bank balances over a
period. The movement in cash flows is classified into the following segments:
Operating Activities: Represents the cash flow from primary activities of a business.

Investing Activities: Represents cash flow from the purchase and sale of assets
other than inventories (e.g. purchase of a factory plant)
Financing Activities: Represents cash flow generated or spent on raising and
repaying share capital and debt together with the payments of interest and
dividends.
View detailed explanation and Example of Cash Flow Statement

Statement of Changes in Equity

Statement of Changes in Equity, also known as the Statement of Retained Earnings,
details the movement in owners' equity over a period. The movement in owners'
equity is derived from the following components:
Net Profit or loss during the period as reported in the income statement
Share capital issued or repaid during the period

Dividend payments
Gains or losses recognized directly in equity (e.g. revaluation surpluses)
Effects of a change in accounting policy or correction of accounting error
View detailed explanation and Example of Statement of Changes in Equity
Link between Financial Statements
The following diagram summarizes the link between financial statements.

Uses of a Financial Statement

Financial Statements are used for a Multitude of Different Purposes

Readers of a financial statement are seeking to understand key facts about the
performance and disposition of a business. They make decisions about the business
based on their reading of the statements. Because financial statements are widely
relied upon, they must be straightforward to read and understand.
For large corporations, these statements are often complex and may include an
extensive set of notes to the financial statements and explanation of financial
policies and management discussion and analysis. The notes typically describe each
item on the balance sheet, income statement, and cash flow statement in further
detail. Notes to financial statements are considered an integral part of the financial
statements.
Owners and managers frequently use financial statements to make important
business decisions, for example:

Whether or not to continue or discontinue part of the business.

Whether to make or to purchase certain materials.
Whether to acquire or to rent/lease certain equipment in the production of
goods.

The documents are also helpful in making long-term decisions and as a source of
historical records.
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Budget
One of the uses of financial statements is as a budgeting tool, as in this example.
Other individuals and entities use financial statements too. For example:
Prospective investors use financial statements to perform financial analysis, which is
a key component in making investment decisions.
A lending institution will examine the financial health of a person or organization
and use the financial statement to decide whether or not to lend funds.
Philanthropies may use financial statements of a non-profit as a component in
determining where to donate funds.
Government entities (tax authorities) need financial statements to ascertain the
propriety and accuracy of taxes and other duties declared and paid by a company.
Vendors who extend credit may
creditworthiness of the business.

use

financial

statements

to

assess

the

KEY POINTS
Owners and managers use financial statements to make important
long-term business decisions. For example: whether or not to
continue or discontinue part of its business, to make or purchase

certain materials, or to acquire or rent/lease certain equipment in

the production of its goods.
Prospective investors use financial statements to perform
financial analysis, which is a key component in
making investment decisions.
A lending institution will examine the financial health of a person or
organization and use the financial statement to decide whether or
not to lend funds

Analysis types:
Common-size analysis

is

the

restatement

of

financial

statement

information in a standardized form.

Horizontal common-size analysis

uses the amounts in accounts in a

specified year as the base, and subsequent years amounts are stated as a
percentage of the base value.
Useful when comparing growth of different accounts over time.

Vertical common-size analysis

uses the aggregate value in a financial

statement for a given year as the base, and each accounts amount is restated as a
percentage of the aggregate.
Balance sheet: Aggregate amount is total assets.
Income statement: Aggregate amount is revenues or sales.

Financial ratio analysis

financial statement accounts
performance of a company.

to

is the use of relationships among

gauge the financial condition and

We can classify ratios based on the type of information the ratio provides: