Financial statements are formal records that provide information about the financial performance and financial position of a business. They are prepared according to accounting standards and help stakeholders such as management, investors, creditors, and regulators make informed economic decisions.
- They should be understandable, relevant, reliable and comparable.
- They are useful in reporting to stakeholders about financial situation of the firm.
- They are useful in business decision making by highlighting the strength and weakness of the firm.
- They are useful in forecasting future financial course of action.
- They are prepared to know about comparative cash flow position of a firm between two periods.
The four key financial statements are:
1. Balance Sheet (Statement of Financial Position)
The balance sheet shows the financial position of a company at a specific point in time. It presents the company’s assets, liabilities, and shareholders’ equity, following the fundamental accounting equation:
Assets= Liabilities + Shareholders’ Equity
- Assets: Resources owned by the company (e.g., cash, inventory, property, equipment).
- Liabilities: Obligations or debts the company owes to outsiders (e.g., loans, accounts payable).
- Shareholders’ Equity: The capital supplied by shareholders (e.g., share capital, retained earnings).
The balance sheet reflects the company’s liquidity, solvency, and overall financial stability.
2. Profit or Loss Statement (Income Statement)
The profit or loss statement also known as the income statement summarizes a company’s revenues, expenses, and net profit or loss over a specific accounting period.
The basic structure is: Net Profit (or Loss)=Revenues−Expenses
- Revenues: Income generated from the sale of goods or services.
- Expenses: Costs incurred to earn revenues, such as salaries, rent, depreciation, and interest.
- Net Profit/Loss: The difference between revenues and expenses; a profit indicates financial success, while a loss signals financial challenges.
This statement helps assess the company’s profitability and operational efficiency.
3. Cash Flow Statement
The cash flow statement shows the inflows and outflows of cash during an accounting period. It provides insights into how a company generates and uses cash.
It is divided into three main sections:
- Operating Activities: Cash flows from day-to-day business operations (e.g., cash received from customers, payments to suppliers).
- Investing Activities: Cash flows from buying and selling long-term assets (e.g., purchase of equipment, sale of investments).
- Financing Activities: Cash flows from funding sources (e.g., issuing shares, borrowing loans, paying dividends).
The cash flow statement helps evaluate liquidity, solvency, and the company’s ability to meet short-term and long-term obligations.
4. Statement of Changes in Shareholders’ Equity
The statement of changes in shareholders’ equity explains the movements in the equity portion of the balance sheet during an accounting period.
It includes:
- Share Capital Issued or Redeemed
- Retained Earnings (profits reinvested in the business)
- Dividends Paid to Shareholders
- Reserves and Other Adjustments
This statement shows how profits are distributed or retained and how ownership interests evolve over time.
