Financial statement

A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity. In British English including United Kingdom company lawa financial statement is often referred to as an account, although the term financial statement is also used, particularly by accountants. For a business enterprise, all the relevant financial information, presented in a structured manner and in a form easy to understand, are called the financial statements. Purpose of financial statements by business entities "The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions."[3] Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position. Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."[3] Financial statements may be used by users for different purposes: Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analysis is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders.

Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labour unions or for individuals in discussing their compensation, promotion and rankings.

Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions.

Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan ordebentures) to finance expansion and other significant expenditures.

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 to a business require financial statements to assess the creditworthiness of the business.

Media and the general public are also interested in financial statements for a variety of reasons.

There are several types of financial statements, but it's important first to put the term financial statements into the right context. The Balance Sheet The balance sheet shows what your company owns, and what it owes. What your company owns is categorized into the Assets column. Within this column, you have two types of assets: current and fixed, or long-term. Current assets are those which are liquid, or in other words, include cash and other assets that can most readily be converted into cash if required. Other current assets include accounts receivables, notes receivables and inventory. Current assets are convertible into cash within one year. It's important to note that cash in the bank from loans you owe are also classified as assets on the balance sheet. Fixed assets, on the other hand, are those which are not liquid, or in other words, are not as convertible to cash relative to current assets. Furniture, equipment, buildings and machinery are classified as fixed assets. One special aspect of fixed assets is that they are typically registered into your balance sheet at their purchase value, so you if you had bought a desk for $500, it would always show on the balance sheet as having a value of $500, rather than the current market value. At the same time, to recognize the fact that fixed assets having a declining value as time passes, we depreciate fixed assets by deducting from the purchase value regularly over a period of time, until we hit the salvage value, or what we may expect to be able to sell the fixed asset for after exhausting its full life span. Fixed assets can also be extended in value. For example, if you renovate your office, you can typically add the renovation cost to the value of the asset, as an appreciation. Liabilities are essentially the opposite of assets - they are what the company owes to its creditors. And just like assets, they are classified into current and long-term. Current liabilities are those which can be paid within one year, and include bills, short-term loans. If your company does have a long-term loan payable, the amount payable for that loan in the current 12 months is also considered to be a current liability. Long-term liabilities are essentially loans or debts that must be paid down over multiple years. For example, a mortgage is considered a long-term liability. When you take what your company owns - assets - and subtract from it what it owes - liabilities, you are left with equity, or what the

company is worth. So, the purpose of a balance sheet is to demonstrate how solvent a company is - or how capable it is to pay its debts and expenses. Of course, a company which consistently increases its equity is one that is being managed well. So balance sheets are one the key types of financial statements to understand because they give you a picture of the company's financial health and give you some strong clues as to how well the company is being managed. The Profit and Loss Statement Another one of the types of financial statements is the profit and loss statement. It's easy to focus too much on this financial statement and not enough on the others, because of its name and purpose - which is to demonstrate a company's profitability for a given period in time. It's a dangerous mistake to give this statement favor over other types of financial statements because a company can be profitable and still not be in a position to pay its bills, and there are many ways a company can be perceived as profitable when in fact, it is inches away from insolvency. Let's first look at the main parts of the profit and loss statement. Where as a balance sheet shows assets on the left and liabilities and equity on the right, profit and loss statements show income at the top, and expenses and profit at the bottom. In some ways, I wish we would instead place the profit line at the top, so we can get to the point, but hey - I didn't invent financial statements! Simply put, when you take income, and subtract from it expenses, you are left with net income, or profit. Of course, the result can be negative, in which case you would call it net loss, or deficit. It's important to note a few things about profit and loss statements: firstly, direct costs of sales, such as materials that are purchased to construct the products you sell, or product packaging, are deducted from gross sales in the income row, and not the expense row. When you deduct these direct costs of sales from gross sales, you are left with net sales. This is important because when you take your net sales and divide it into your gross sales, you see your company's gross sales margin, or gross margin. Why is gross margin important? Because it tells you how much you need to spend on a unit of sale as a result of making the sale. It tells you how much it costs you to sell one unit of your product. In the case of a service, direct costs are usually associated with hours worked, particularly if an hourly fee is involved. However, payroll and wages are not considered direct costs - they are classified as expenses. Another important note is that when you depreciate the value of an asset on your balance sheet, it shows up as a depreciation expense in your profit and loss statement, in the expenses row. Even though your company didn't actually spend that money, for accounting purposes, the company would record the depreciation as an expense and thus reduce the value of the profit.

Taxes for businesses, are calculated on a percentage of the profit, and not on gross income. This is the key difference between employment income tax and business income tax. The lower the profit a business experiences, the less tax it pays. The Cash Flow Statement The cash flow statement is the key link between the balance sheet and the profit and loss statement, and is often overlooked because its purpose is so often misunderstood. Like the other types of financial statements we've talked about, the cash flow statement has two key sections: inflows and outflows. But the purpose of the cash flow statement is to see the movement of cash (as opposed to income) within your company - hence the name - cash flow statement. Why is a cash flow statement so important? In fact, it's arguably the most important of all types of financial statements because it lets you know whether you have enough cash flowing in at any given period to cover expenses and other cash outflows, such as investments. Essentially, the cash flow statement will let you know whether your company has a positive or negative cash flow, or more importantly, whether it has a positive cash balance. It's not necessarily a bad thing to have a negative cash flow in some periods, but a consistent negative cash flow is unhealthy, naturally. For example, you might have made a big investment or expenditure in one month, which makes your outflows greater than your inflows. But what must not happen is for your company to ever have a negative cash balance, because that really means, in no uncertain terms, that your business is bankrupt! A negative cash balance means that you have no money in the bank to pay the bills and debts. A good cash flow is indicated in the cash flow statement, and lets you know how well the company is managing its financials - as in what is owed to it and what it owes back, and how effectively both can be converted. Historical vs. Projected Financial Statements Each of these types of financial statements can be viewed either historically or as projections. Most of the time, we are working with historical financial statements, which are factual, as they describe financial situations that occurred in the past. Projected financial statements, on the contrary, focus on a future situation, and since the future is uncertain, are not factual like historical financial statements. Instead, projected financial statements are used to plan or forecast a period or timeframe. This is especially useful - and necessary - in writing a business plan. Still, good business financial

projections are based on historical trends, so the two types of financial statements go hand in hand in this sense. Comparative Financial Statements Financial statements are often compared between periods to gain an understanding of performance or trends. Businesses will regularly compare the previous month to the month prior - so February would be compared to January, for example. But it's also normal practice to compare the same months in different years. For instance, to understand how a company has performed this year compared to last year, they might compare January this year to January last year. Another comparison businesses make is to measure actual results against a planned result. So, if your company planned to have a certain level of revenue in June, you would compare the June actual financials once you have them, to the projected financial statements. And you can do this with each of these types of financial statements. Summing up the Types of Financial Statements Remember - there are three key types of financial statements to prepare for any given period. They can be viewed historically, and can also be planned for future expectations. And of course, financial statements can be used to compare results between periods, or to measure performance against a planned result. Ultimately, each of these types of financial statements help you gain a better picture of a company's financial performance and health. Investors use them to decide whether to invest money in a company, the government uses them to check for consistency with the law and proper taxation, and companies use them to measure their status and progress, and to plan ahead.