As previously mentioned, there are three primary financial documents that companies are expected to produce: the balance sheet, income statement, and cash flow statement. Together these financial documents are sometimes referred to as a company's "financials." They serve several purposes including guiding management, providing insights for investors, and satisfying financial regulators. The following section will explore each of these three types of financial statements in detail.
The Balance Sheet
The balance sheet is a financial document that provides a snapshot of a company's assets, liabilities, and equity at a specific point in time. Assets are anything of value that a company owns and can use to generate revenue. Assets can be further broken down into two categories: current assets and long-term assets. Current assets are assets that can be converted into cash within one year's time while Long-term assets are assets that will take longer than one year to convert into cash.
Liabilities are obligations a company owes to others, such as debts or lease payments. Like assets, liabilities can also be divided into two categories known as current liabilities and long-term liabilities. Current liabilities are obligations that must be paid within one year while long-term liabilities are obligations that are not due for more than one year. Equity is the difference between a company's assets and liabilities and represents the ownership interest that shareholders have in a company.
The balance sheet may sometimes be referred to as a "statement of financial position." The balance sheet is an important measure of a company's financial health since it provides insights into its ability to pay its debts and generate revenue. For example, if a company has more assets than liabilities, then it could be said to have a positive net worth. Conversely, a company with more liabilities than assets could be said to have a negative net worth. A company with a negative net worth may have difficulty paying its debts and could be at risk of bankruptcy. Thus, the balance sheet is an important document for creditors and investors to review when considering lending money to or investing in a company.
A balance sheet can be prepared using either the accrual basis or the cash basis of accounting. The accrual basis of accounting recognizes revenue when it is earned and expenses when they are incurred, regardless of when the cash is actually received or paid. The cash basis of accounting, on the other hand, only recognizes revenue and expenses when the cash is actually received or paid.
The Income Statement
The income statement is a financial document that shows a company's revenues and expenses over a specific period of time. The income statement can be used to calculate a company's net profit or loss for the period. Net profit is also known as net income. Net profit can be calculated by subtracting a company's total expenses from its total revenue. If a company has a positive net profit, it means that the company earned more revenue than it spent. If a company has a negative net profit, it means that the company spent more than it earned.
The income statement is an important financial document because it provides insights into a company's profitability. For example, if a company consistently has a negative net profit, it may be at risk of bankruptcy. An income statement is also a useful tool for financial planning and decision-making. For instance, a company may use its income statement to decide whether to expand its operations or cut costs.
The Cash Flow Statement
A cash flow statement is a financial document that details the money flowing into and out of a company. The cash flow statement shows where cash is being generated (from sales, investments, etc.) and where it is being spent (on expenses, debt payments, etc.). The cash flow statement is an important financial document because it provides insights into a company's ability to generate and manage its cash flow.
The cash flow statement is composed of three core sections known as operating activities, investing activities, and financing activities. Operating activities include cash inflows and outflows from the day-to-day operations of the business. Investing activities include cash inflows and outflows from investments, such as the purchase of equipment or real estate. Financing activities include cash inflows and outflows from activities such as issuing debt, equity, and paying dividends.
The cash flow statement is important because it provides insights into a company's liquidity, which is a measure of its ability to pay its short-term obligations. For example, if a company has more cash inflows than cash outflows, then it is said to have a positive cash flow. This typically means that the company has enough cash on hand to pay its bills. On the other hand, if a company has more cash outflows than cash inflows, then it is said to have a negative cash flow. This could possibly mean that the company may have difficulty paying its bills.
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FAQs
They are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders' equity. Balance sheets show what a company owns and what it owes at a fixed point in time. Income statements show how much money a company made and spent over a period of time.
What is financial statements definition and purpose? ›
A financial statement is a report that shows the financial activities and performance of a business. It is used by lenders and investors to check a business's financial health and earnings potential.
What is the meaning of financial documents? ›
Financial documents, also known as financial statements, are used for reporting financial information about a business, in a standardized format. They include a balance sheet, an income statement, and a cash flow statement. A balance sheet is a snapshot in time of the financial condition of your business.
How many types of financial documents are there? ›
The three main types of financial statements are the balance sheet, the income statement, and the cash flow statement. These three statements together show the assets and liabilities of a business, its revenues, and costs, as well as its cash flows from operating, investing, and financing activities.
What are the 3 major purposes of financial statements? ›
The income statement, balance sheet, and statement of cash flows are required financial statements. These three statements are informative tools that traders can use to analyze a company's financial strength and provide a quick picture of a company's financial health and underlying value.
What are 5 elements of financial statements? ›
The major elements of the financial statements (i.e., assets, liabilities, fund balance/net assets, revenues, expenditures, and expenses) are discussed below, including the proper accounting treatments and disclosure requirements.
What are the five financial statements and their definitions? ›
- The Income Statement (pointing out if the company made a profit, also called Profit & Loss Statement) - The Shareholder's Equity Statement (Net Worth, or Capital statement) - Cash Flow Statement (states whether the company generated cash) - Balance Sheet Statement (quick overview of company's health)
What is all purpose financial statement? ›
General purpose financial statements (GPFS) are a set of financial reports that are intended to be used by a wide range of users, including investors, creditors, regulators, and management. The most common general purpose financial statements are: the balance sheet. income statement.
What best defines financial statements? ›
A financial statements definition is, in the simplest sense, any document that helps show the financial state of your company. The actual items that meet this financial statements definition are generally much more specific, and each has an important role to play.
What is the most important financial document? ›
Typically considered the most important of the financial statements, an income statement shows how much money a company made and spent over a specific period of time.
The balance sheet, income statement, and cash flow statement each offer unique details with information that is all interconnected. Together the three statements give a comprehensive portrayal of the company's operating activities.
What is an example of a financial document? ›
There are three primary types of financial documents: the balance sheet, the income statement, and the cash flow statement. Each type of financial statement provides different information that can be used to assess a company's financial condition.
What are the golden rules of accounting? ›
The three golden rules of accounting are (1) debit all expenses and losses, credit all incomes and gains, (2) debit the receiver, credit the giver, and (3) debit what comes in, credit what goes out.
What financial documents should you keep? ›
Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return.
What are the 4 general purpose financial statements and in what order are they prepared? ›
Typically, you'll need all four: the income statement, the balance sheet, the statement of cash flow, and the statement of owner equity. By preparing these four accounting financial statements, you will be able to see how well your company's finances are doing or find areas that need improvement.
What are the 4 components of the financial statements? ›
Financial statements can be divided into four categories: balance sheets, income statements, cash flow statements, and equity statements.
Which of the 4 financial statements do you think is the most important and useful in predicting a company's success? ›
The balance sheet is particularly important as it provides a snapshot of a company's financial position at a specific moment in time, empowering a business owner or manager to establish the company's most important ratios such as solvency versus liquidity that are particularly important for debt management.
What is the order of the four financial statements? ›
They are key parts of an annual report. The order usually is: the income statement, the balance sheet, the statement of changes in equity, and the cash flow statement. The income statement starts off by showing company earnings and expenses. This tells us if the company made a profit or a loss.
