Financial Statements: List of Types and How to Read Them

The same logic holds true for taxes payable, salaries, and prepaid insurance. If something has been paid off, then the difference in the value owed from one year to the next has to be subtracted from net income. If there is an amount that https://www.adprun.net/ is still owed, then any differences will have to be added to net earnings. Add the change in cash to the beginning cash balance to arrive at the ending cash balance, ensuring it matches the cash balance reported on the balance sheet.

Income Statement

However, when interest is paid to bondholders, the company is reducing its cash. And remember, although interest is a cash-out expense, it is reported as an operating activity—not a financing activity. The articles and research support materials available on this site are educational impairment definition and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Finance Strategists has an advertising relationship with some of the companies included on this website.

The Statement of Cash Flows

Forward-looking financial statements rely on estimates and assumptions, which may not always be accurate and are subject to change. The lack of any appreciable standardization of financial reporting terminology complicates the understanding of many financial statement account entries. There’s little hope that things will change on this issue in the foreseeable future, but a good financial dictionary can help considerably. The numbers in a company’s financial statements reflect the company’s business, products, services, and macro-fundamental events. These numbers and the financial ratios or indicators derived from them are easier to understand if you can visualize the underlying realities of the fundamentals driving the quantitative information.

What are financial statements?

For example, before you start crunching numbers, it’s critical to develop an understanding of what the company does, its products and/or services, and the industry in which it operates. Using the direct method, actual cash inflows and outflows are known amounts. The cash flow statement is reported in a straightforward manner, using cash payments and receipts. Analyzing changes in cash flow from one period to the next gives the investor a better idea of how the company is performing, and whether a company may be on the brink of bankruptcy or success. The CFS should also be considered in unison with the other two financial statements (see below).

Statement of Financial Position

Recording transactions is the gateway through which all the information needed to prepare financial statements flows. Sales, purchases, returns—every transaction impacts your financial statements. You may see large companies prepare financial statements following GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). Preparing financial statements is a crucial skill to learn for any founder.

Limitations of Financial Statements

Investors can use key reports, such as a balance sheet, cash flow statement, and income statement, to evaluate a company’s performance, helping to make more informed investment decisions. Financial statements play a vital role in maintaining the integrity of the financial system and promoting trust between companies and investors. Financial statements provide key details for understanding a company’s financial health. The balance sheet depicts a company’s liabilities, assets, and equity; the income statement details revenues and expenses; while the cash flow statement lists all the cash going in or out of the company. All of this information is essential to form a complete and well-rounded understanding of a company’s financial performance. These cash flows are divided into cash flows from operating activities, investing activities, and financing activities.

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By analyzing your net income and cash flows, and looking at past trends, you’ll start seeing many ways you can experiment with optimizing your financial performance. In either case, your cash flow statement has shown you a different side of your business—the cash flow side, which is invisible on your balance sheets and income statements. Most small businesses track their financials only using balance sheets and income statements. But depending on how you do your financial reporting, you may need a third type of statement.

They can be used to assess a company’s financial health, performance, and cash flow. Lastly, annual financial statements are crucial for tax reporting and tax return filing. Documenting income, expenses, assets, and liabilities in the statements simplifies completing the paperwork required by tax authorities each year. When seeking outside investment or loans, these statements offer shareholders and creditors crucial details to assess the company’s creditworthiness, risks, and potential returns on investment or loans. Properly prepared financial statements could make securing necessary funding more attainable.

The 3 main components of a balance sheet consist of assets, liabilities, and shareholders’ equity. A personal financial statement shows the individual’s net worth—their assets minus their liabilities—which reflects what that person has in cash if they sell all their assets and pay off all their debts. If their liabilities are greater than their assets, the financial statement indicates a negative net worth.

We’ve simplified the concepts and processes you need to understand in this quick guide. Earnings per share (EPS) is a crucial financial metric in determining a company’s profitability. It represents the portion of a company’s profit allocated to each outstanding share of common stock. To calculate EPS, divide the net income by the weighted average number of outstanding shares.

Profit refers to the amounts that remain with the company after all of a company’s expenses have been deducted from total revenues. Cash flow, on the other hand, simply refers to the cash amounts going in and out of the company. A cash flow statement will visualize what type of operations generate cash for a company. Based on how much cash is flowing into and out of the company during the accounting period, you will be able to evaluate a firm’s ability to operate in the short- and long term. The model enables financial analysts to forecast a company’s future financial statements. Such forecasts are necessary to visualize how a company’s investing, operating, and financing decisions interact to affect the bottom line in the future.

It’s important to note that equity is only the “book value” of your company. But total assets can also include things like equipment, furniture, land, buildings, notes receivable, and even intangible property such as patents and goodwill. For example, banks move a lot of money, so they prepare a balance sheet every day. On the other hand, a small Etsy shop might only get a balance sheet every three months. Sales revenue, the top line, is all the money that has come into the business during the month, before taking any expenses into account.

1. In this article, we are going to take a look at the different types of financial statements, as well as how to prepare and interpret these documents.
2. An individual’s financial statement is referred to as a personal financial statement and is a simpler version of corporate statements.
3. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching.
4. Once you have the closing balance for the retained earnings account, add it to the opening balance of owners’ equity.
5. The statement divides the cash flows into operating cash flows, investment cash flows, and financing cash flows.
6. But if you use the accrual method of accounting, a statement of cash flows is essential for measuring your financial health.

This demonstrates the amount of cash generated by the business or used from its ongoing business operations. This can include salaries paid to employees, payments from customers, and cash paid to suppliers. This purchase will entail an increase in assets (equipment) and a liability (credit purchase) for the amount of $2,000.

Each of these components plays a crucial role in painting a complete picture of a company’s financial situation. The balance sheet outlines a company’s assets, liabilities, and shareholders’ equity, showcasing its net worth at a specific point in time. The income statement, on the other hand, illustrates a company’s revenues and expenses over a particular period, indicating its profitability.

This might be retained revenue—money the company has earned to date—as in the example above. Your current liability can change month to month as you pay down the principle on a debt; calculating an average takes that into account, so you can get a ballpark figure. Subtractions from cash reverse any transactions that were recorded as revenue for the month, but not actually received. These three financial ratios let you do a basic analysis of your balance sheet. When you know how to read your financial statements, you can find ways to make more profit, expand your business, or catch problems before they grow.

The balance sheet compiles how much a company owes and how much money it has borrowed within the same document. This makes it easy for financial analysts to quickly determine the company’s leverage and liquidity levels with simple financial ratios. In addition, professional standards don’t require CPAs to be independent of a business when preparing its financial statements. In other words, it’s OK for an accountant to have a financial interest in a company that he or she prepares financial statements for.

He recognized that “a lot of people don’t understand keeping score in business. They get mixed up about profits, assets, cash flow, and return on investment.” A cash flow statement is a valuable measure of strength, profitability, and the long-term future outlook of a company. The CFS can help determine whether a company has enough liquidity or cash to pay its expenses.