These statements represent a formal record of the financial activities of an entity. They are written reports that quantify the financial strength, performance and liquidity of a company. Financial statements reflect the financial effects of business transactions and events on the company.
Types of Financial Statements
Statement of financial position, also known as the Balance Sheet, presents the financial position of an entity at a given date. It is comprised of the following
- Assets: Something a business owns or controls (e.g. cash, inventory, plant and machinery, etc)
- Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)
- Equity: What the business owes to its owners. Equity therefore represents the difference between the assets and liabilities.
Also known as the Profit and Loss Statement, reports the company’s financial performance in terms of net profit or loss over a specified period. Income statement is composed of the following :
- Income: What the business has earned over a period (e.g. sales revenue, dividend income, etc)
- Expense: The cost incurred by the business over a period (e.g. salaries and wages, rental charges, etc)
Net profit or loss is arrived by deducting expenses from income / revenue.
Cash flow statement, presents the movement in cash and bank balances over a period.
- Operating Activities: Represents the cash flow from primary activities of a business.
- Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant)
- Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.
- Statement of Changes in Equity, also known as the Statement of Retained Earnings, details the movement in owners’ equity over a period. It is derived from the following components:
- Net Profit or loss during the period as reported in the income statement
- Share capital issued or repaid during the period
- Dividend payments
- Gains or losses recognized directly in equity (e.g. revaluation surpluses)
- Effects of a change in accounting policy or correction of accounting error
The statements are used by so many different types of people from investors, to creditors, managers and even employees. Proven useful tools that provide valuable information about a business enabling the user of the statements to make the most appropriate business decisions.
Why Are Financial Statements Important?
When a company issues financial statements, it provides information to investors and creditors. This information details how the company is doing financially. With this information, investors can decide whether they should invest in a company. Alternatively, current investors will be able to decide if they want to continue to invest in the company.
Companies generally issue financial statements every quarter. It is important for a company to file these reports on time. The government can impose fines if financial statements are not filed. It is also important that companies do not fudge their financial statements in any way. This is because investors will not want to finance a company that could be hiding something.