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.
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
Types of financial statements
Cash flow statements
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:
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.
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.
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:
Accumulated other comprehensive income
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|
|Property, Equipment||$160,000||Stockholders' Equity||$155,000|
|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|
|Total Revenues and Other Income||$80,000|
|Cost and Other Deductions|
|Crude Oil and Product Purchases||$50,000|
|Total Cost and Other Deductions||$72,500|
|Income Before Income Taxes||$7,500|
|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|
|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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