Understanding Financial Statements

In my last post, I discussed the 10 basic elements of financial accounting. The basic elements form the basis of the four financial statements which I will discuss today.

Investopedia defined financial statements as “written records that convey the business activities and the financial performance of a company”.

According to International Accounting Standard, the objective of financial statements is to provide information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users in making economic decisions.

To gain a full picture of an entity, all four statements should be read and analyzed together.

  1. Statement of Financial Position

When you are seeking to know the financial condition of an entity, the statement of financial position is your plug. The statement of financial position provides information about the resources, obligations, and capital position of an entity at a point in time. This is the foremost financial statement because the other three financial statements can be derived from it.

The statement of financial position also known as the balance sheet is represented by the formula:

Assets = Liability + Owner’s Equity.

2.         Statement of Profit or Loss and Other Comprehensive Income

Another statement to look out for is the statement of profit or loss and other comprehensive income (commonly called Profit or Loss account). This statement is a summary of the financial results of an entity’s qualifying operating and non-operating events over a period. The profit or loss account provides users with information about how profitable an entity has operated.

The accounting formula for the statement is: Profit or loss = (Revenues + Gains) – (Expenses + Losses)

The total profit or loss for the period brings about an increase or decrease respectively in the entity’s capital. Remember that capital is one of the contents of a statement of financial position discussed above.

3.         Statement of Cash Flows

To understand the outward and inward movement of cash from and to an entity over a period, the statement of cash flows explains this beautifully. The statement of cash flow shows how cash moves in and out of an entity during a period. Using the indirect method, the statement of cash flow is prepared by comparing the increase or decrease of assets, liabilities, and capital between two financial periods.

This statement categorized business activities into three: operating, investing, and financing.

4.         Statement of Changes in Equity

The statement of changes in equity is a financial statement that provides information about increases or decreases in capital for a period. This statement is also related to the statement of financial position, as it explains why and how capital has increased or decreased.

Actioning insights drawn from these financial statements can accelerate organizational performance.


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