Financial Statements are a barometer of a company’s overall business performance and financial health; and are critical in making decisions regarding expansion and financing. This information feeds into the broader marketing strategy, as well as serves to provide a clearer picture on the company’s return on investment. While it would be beyond the scope of this article to enumerate all the reasons why financial statements are important to a business, as there are many, let us look into the three key components that form the framework of a financial statement:
- The Balance Sheet
- The Income Statement
- Statement of Cash-flows
The Balance Sheet
One of the three fundamental financial statements, the balance sheet is key to both financial modeling and accounting. It is also referred to as a statement of net worth, or a statement of financial position. The balance sheet displays the company’s total assets, and how these assets are financed- either through debt or through equity.
In financial accounting, the balance sheet is a summary of the financial balances of an individual or organization; whether it be a sole proprietorship, business partnership, corporation, private limited company, or other organizations such as Government or not-for-profit entities. Of all the key financial statements, the balance sheet is the only statement which applies to a single point in time of a business’ calendar year; with assets, liabilities and ownership equity being listed as of a specific date.
The balance sheet provides insight into the amount of money invested by shareholders, as well as what the company owes and owns. It is particularly helpful in determining the state of the entity’s liquidity risk, financial risk, credit risk and business risk. When analyzed over several accounting periods, balance sheets can help uncover underlying trends in the financial position of the company.
The Income Statement
The income statement, also known as the profit and loss statement or the statement of revenue and expense, is one of the major financial statements used to analyze a company. It primarily focuses on the company’s revenues and expenses during a particular period. This report reveals the financial performance of an organization, and its purpose is to show investors and managers whether the company made or lost money during the period being reported. This information is key in evaluating the overall value of a company and its share price.
The income statement is generated by taking the total revenue, and then subtracting all expenses incurred during the period to arrive at a net profit or loss
Statement of Cash-flows
A cash flow statement provides data regarding all cash inflows a company receives from its ongoing operations and external investment sources. It includes cash made by the business through operations, investment, and financing—the sum of which is called net cash flow. This statement quantifies how well a company manages its cash position, meaning its ability to effectively generate income to pay off debt and fund internal operations. The cash flow statement has three components:
- The first section of the cash flow statement is cash flow from operations, which includes transactions from all operational business activities.
- Cash flow from investment is the second section of the cash flow statement; and is the result of investment gains and losses.
- Cash flow from financing is the third and final section, which provides an overview of cash used from debt and equity.
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