What Are Financial Statements? A Beginner’s Guide

By Indeed Editorial Team

Updated September 30, 2021 | Published February 4, 2020

Updated September 30, 2021

Published February 4, 2020

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Financial statements are useful accounting measures that can help a business keep track of all of its expenses and profits. If you are interested in understanding how to calculate and interpret your financial statements, it may be helpful to understand what different types of financial statements you can use and why they are important to your business.

In this article, we define what financial statements are, look into four main types and provide examples to help deepen your understanding of how they are calculated and formatted.

man writing notes on a desk

What are financial statements and why are they important?

Financial statements are a collection of written records that reflect a summarized version of an organization's financial position, cash flows and results. Financial statements are typically audited by accountants, government agencies, and other firms and organizations who verify the accuracy of a company's financial reporting for financing, investing or tax purposes.

Financial statements are important for businesses to prepare and analyze for several reasons:

  • To demonstrate a business's ability to generate cash

  • To provide an accurate idea of whether a business can pay back its debts

  • To identify any profitability issues while tracking and calculating expenses and revenue

  • To illustrate financial relationships that can represent the condition of a business

  • To investigate business transactions

  • To help companies make informed business decisions

Related: How To Conduct an Analysis of Financial Statements

Types of financial statements

  1. Balance sheets

  2. Income statements

  3. Cash flow statements

  4. Statements of shareholders' equity

1. Balance sheets

Balance sheets offer detailed information about a company's assets, liabilities and shareholders' equity. A balance sheet does not show the money that goes into or out of a company's accounts.

  • Assets are items owned by a company that have value. Assets can be used or sold by a company to provide services or make products. The assets a company owns may include physical property such as equipment, trucks and inventory, or it may include trademarks, patents and investments.

  • Liabilities are sums of money that a company owes to others. They include rent, money borrowed from a bank, payroll owed to its employees or taxes owed to the government.

  • Shareholders' equity is the money that would remain after a company paid off all of its liabilities and sold all of its assets. The money that remains after all assets are sold and liabilities are paid off is money that belongs to the shareholders, or owners, of a company. Shareholders' equity is often referred to as net worth or capital.

A company's balance sheet is usually set up as a basic equation in accounting. Companies list their assets on the left side of the balance sheet and they list their liabilities and shareholders' equity on the right side.

The formula for a balance sheet is as follows:

Assets = Liabilities + Shareholders' equity

Assets are generally listed by how quickly they can be converted into cash. For example, inventory may be listed first because a company expects to sell its inventory in a year. Liabilities are listed based on their due dates. Liabilities are considered either current or long-term. Current liabilities are expected to be paid off within the year and long-term liabilities are due more than a year away. Shareholders' equity is listed as the amount owners invested in a company's stock after that company's losses or earnings are accounted for from inception.

2. Income statements

An income statement reflects the revenue a company has earned over a period of time. Income statements also display the expenses incurred while earning that revenue. The top of the income statement lists the gross sales revenue. Returns and allowances are then subtracted from the gross amount so the second line of the statement portrays the net sales a company has.

A company makes deductions at each step in the income statement for certain costs or other operating expenses associated with earnings. The last line of the statement lists the company's net earnings or losses, which tells you how much a company has earned or lost in that fiscal year.

3. Cash flow statements

Cash flow statements summarize the movement of cash and cash equivalents in and out of a company. A cash flow statement takes information from a company's balance sheet and income statement and reorders it to tell you whether or not the company generated cash. Cash flow statements are divided into three main parts to facilitate reviewing the cash flow from each of these activities:

Operating activities

The first section of a cash flow statement analyzes a company's income cash flow from net income and losses. This section of cash flow adjusts the net income shown on the income statement to the cash the company received or used during operating activities. For instance, depreciation, deferred tax, amortization, gains or losses related to a noncurrent asset and dividends (revenue received from investing activities) are usually included.

Investing activities

The second section of a cash flow statement displays the cash flow from any investing activities. This includes the purchases or sales of long-term assets, as well as investment securities. For instance, if a company buys a machine, the cash flow statement would show this as an investing activity because it used cash to buy an asset.

Financing activities

The third section of a cash flow statement reflects cash flow from all financing activities. Sources of cash flow include borrowing from banks, selling stocks and bonds to raise cash. When noting capital raised, it is considered "cash in." When dividends are paid, they're recorded as "cash out."

4. Statements of shareholders' equity

This statement is developed from the balance sheet statement and provides additional information about shareholders' equity during a reporting period. Shareholders' equity statements are useful for disclosing stock sales and repurchases by the business reporting the information.

The beginning balance is set up across the top of the grid-like report, with additions and subtractions from the balance located in the middle of the report. The ending balances are located at the bottom of the report after the additions and subtractions are incorporated. There should be figures totaled at the top and bottom of the report for the total amount of beginning and ending shareholders' equity. The columns in the report may include the following:

  • Treasury stock

  • Accumulated other comprehensive income

  • Totals column

  • Common stock

  • Preferred stock

  • Retained earnings

Related: Definitive Guide: 4 Financial Statements for Businesses

Examples of financial statements

Financial statements are best understood with visual representations. Here are some condensed examples:

Example 1: Balance sheet

Formula: Assets = (Liabilities + Shareholders’ Equity)

Below are the figures for XE Oil company as of October 2019:

  • Total assets were $300,000

  • Total liabilities were $115,000

  • Total equity was $155,000

  • The total liabilities and equities were $270,000

XE Oil Company Financial
Balance sheet (in millions)
Assets Liabilities and Stockholders' Equity
Current Assets $100,000 Current Liabilities $50,000
Investments $10,000 Long-term Liabilities $65,000
Property, Equipment $160,000 Stockholders' Equity $155,000
Other Assets $30,000
Total Assets $300,000 Total Liabilities & Stockholders' Equity $270,000

Example 2: Income statement

An income statement reports a company's financial performance over a certain accounting period and is also known as the profit and loss statement. It provides a company's net income after expenses are subtracted from revenues.

Formula: Net Income = (Revenue − Expenses)

Below are the figures for XE Oil company that will help to determine the company's net income:

  • Total revenues were $80,000

  • Total costs were $72,500

  • Income taxes were $1600

  • Net income or profit was $5,900

XE Oil Company
Statement of Income (in millions)
Revenues and Other Income
Sales and Other Operating Revenue $72,000
Income from Equity Affiliates $6,000
Other Income $2,000
Total Revenues and Other Income $80,000
Cost and Other Deductions
Crude Oil and Product Purchases $50,000
Manufacturing Expenses $20,000
Interest Expense $500
Depreciation $1,000
Other Taxes $1,000
Total Cost and Other Deductions $72,500
Income Before Income Taxes $7,500
Income Taxes $1,600
Net Income Attributable to XE Oil $5,900

Example 3: Cash flow statement

The cash flow statement measures how well a company generates cash during a specific period. It uses this cash to fund investments, operating expenses and to pay debt obligations.

Below are the figures that will help you determine XE Oil company's cash flow:

  • Operating activities generated a positive cash flow of $25,000

  • Investing activities generated cash outflows or negative cash flow of -$10,200

  • Financing activities generated cash outflows of -$12,500 for the period

XE Oil Company
Cash Flow Statement
Cash Flows from Operating Activities
Net income $15,000
Depreciation $12,000
Changes in Operational Working Capital ($500)
All Other Items-Net ($1,500)
Net Cash Provided by Operating Activities $25,000
Cash Flows from Investing Activities
Additions to Property ($14,500)
Sales and Returns of Investment $4,000
Additional Advancements and Investments ($3,000)
Other Investment Activities $3,000
Net Cash Used in Investing Activities ($10,200)
Cash Flows from Financing Activities
Additions to long-term debt
Additions to short-term debt
Reductions in short-term debt
Reductions in Short-Term Debt
Cash Dividends to Shareholders
Cash Dividends to Non-Controlling Interests $400
Common Stock Acquired $1,600
Net Cash Used in Financing Activities ($12,500)
Increase in Cash and Cash Equivalents $2,500
Cash and Cash Equivalents at Beginning of Period $3,000
Cash and Cash Equivalents at End of Period $5,500

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