The 3 financial statements of a publicly traded company define the foundation of corporate accounting and showcase the overall financial position. These financial statements are a bird’s eye view of the organization’s financial strength.
Having a critical analysis of these statements is important for investors, lenders, traders, shareholders, investment bankers, financiers, and key stakeholders. These statements portray a comprehensive financial picture of the company and they are complexly interrelated.
You need to have a crystal clear understanding of these statements of financial position. Let’s unlock business insights with a perfect understanding of these financial pillars.
The Income Statement – 3 Financial Statements
A sneak peek at the company’s financials starts by comprehending the income statement. The income statement also referred to as a profit and loss (P&L) statement lists the revenue earned by the company along with the expenses incurred for operational processes.
It is important to remember that the concepts of accrual accounting are the basic formulation of the income statement/p&l statement. This statement is for a certain period such as a quarter or a complete year. Following are the components of the income statement in descending order:
- Total Revenue
- Direct Expenses (cost of goods sold)
- Gross Profit
- Indirect Expenses (salaries, depreciation, amortization, etc.)
- Operating Income
- Capital Expenses (tax, interest)
- Net Income (Bottom Line)
The income statement starts with “total revenue” as the top line. It is the total sales done by a business over a period of time. Under the revenue, you will see the direct expenses that impact the revenue generation. Generally, the cost of goods sold (COGS) is the direct expense.
The direct expenses subtracted from the revenue will give the gross profit.
Moving forward down the income statement, the indirect expenses are recorded. You will have to subtract these indirect costs from the gross profit to calculate the operating income. Finally, the last expenses to be added to the statement are income taxes and interest rates.
Deduct the taxes from the operating income to get the concluding value of the income statement; the net income.
The net income is also known as the “Bottom Line” of the income statement and is the crux. Analysts use the profitability numbers from this statement to calculate different ratios. Thus, this financial statement provides key information for making informed decisions.
The Balance Sheet
Among the 3 financial statements, a balance sheet is the most important in determining the financial position of a company/organization. A balance sheet will provide the book value of a company which is the difference of total assets and liabilities.
The balance sheet has three components and the formulation:
- Total assets
- Total liabilities
- Shareholders’ equity
Assets = Total liabilities + Shareholders’ Equity
This financial sheet is made for any specific date and the final write-off should match the assets’ value. Based on these three parts of a balance statement, financial analysts can come to different conclusions.
They can calculate certain insights such as the book value which is the difference between total assets and total liabilities. Furthermore, they can calculate the total capital of the company which is the summation of total liabilities and shareholders’ equity.
Taking this sheet as a benchmark, financial analysts and investors can determine the long-term and short-term assets and liabilities of the company. In conclusion, the balance sheet depicts the financial management of a company.
Cash Flow Statement – 3 Financial Statements
The prime outcome of a cash flow statement is to determine the liquidity of a company. Liquidity refers to how quickly a company can convert its assets into cash. Since this statement deals with cash, therefore, it is based on cash accounting instead of accrual accounting.
The cash flow statements record cash inflows and outflows. Thus, it gives an accurate picture of the company’s liquidity. In simple terms, a cash flow statement represents the cash available during any accounting period.
To compile this statement, you will need to record cash transactions over the designated period. There are three sources of cash transactions that are duly considered for the creation of cash flow statements. The sources are as follows:
- Operating
- Investing
- Financing
The operation section comprises cash earned from the business sales or from operational activities. Furthermore, operational cash outflows are also a part of this section to record the amount spent to carry out the sales or operating activities.
The cash transactions from investing activities are the ones in which you purchase or gain assets from the invested assets. It is to be noted that the transactions in this section are closely connected with the capital planning for the firm.
Lastly, the financing cash inflows and outflows list the transactions from borrowing debt and selling shares/stocks of the company. In this case, the outflows are usually stock dividends or interest-related payments.
Creating this statement is a hard nut to crack as you may get confused while categorizing different transactions. Despite the effort required, the cash flow statement provides very useful insights into the financial standings of a business.
Concluding Remarks
Without any iota of doubt, all the 3 financial statements are of topmost importance in assessing the financial health of an organization. These statements provide a comprehensive overview of the financial statistics of a company. Resultantly, they allow investors, owners, shareholders, or lenders to make decisions.
Without a comprehensive understanding of these statements, it is impossible to draw a clear picture of a company’s finances. Furthermore, the complex interconnection of these financial statements plays an important role in financial reporting.
