What is a Financial Statement?
Financial Statements (FS) are records of commercial and economic activities of a business or entity. They convey the financial performance of a company and are designed to present information clearly and concisely. Learning how to read FS is one of the first necessary steps to become financially literate and start investing.
- Balance Sheet (or statement of financial position)
- Statement of Income (or P&L)
- Statement of cashflow
- Statement of changes in equity
The building block of Financial Statements
Transactions are the building blocks of any FS. They are economic exchanges between entities (i.e., Businesses and People).
They can be, for instance, a sale or a purchase; the receipt of cash by a borrower; the payment of money by a lender. Entities keep track of these transactions by summarizing and classifying them into different categories called accounts. Accounts are ledgers that record any transaction affecting assets, liabilities, stockholders’ equity, revenues, and expenses.
For example, a cash account reports all the transactions related to cash in one single ledger. FS summarize the content of each account and combine them in one unique dataset.
Who uses Financial Statements?
Managers, c-suite executives, and investors use FS to make informed decisions regarding new investments and understand the overall financial health of companies. Investors use FS to determine the present value (PV) of a business and to predict companies’ future performance using, for example, ratio analysis.
Who prepares Financial Statements?
Management is usually responsible for the preparation and integrity of FS. It relies on internal accountants to keep track of transactions and accounts necessary to write FS.
Nevertheless, companies, managers, and accountants often make mistakes. Therefore, companies often hire outside independent accountants, called auditors, to make sure that their FS are presented fairly.
Where can you find Financial Statements?
The big four Financial Statements?
As we already mentioned, there are four main FS: balance sheet, statement of income, statement of cashflow, and statement of changes in stockholders’ equity.
The balance sheet is a listing of an entity’s resources (assets), obligations (liabilities), and owners’ claim (stockholders’ equity) at a point in time. It is, in essence, a snapshot of the organization’s financial position, frozen at a specific point in time.
Statement of Income
The statement of income main scope is to highlight whether an entity operates at a profit or loss. It reports results for a period of time and does not focus on a single date like the balance sheet. The statement of income is thus more like a movie than a snapshot.
Statement of Cashflow
The statement of cashflow is used to identify the sources and uses of cash during a distinct period. It is most useful to evaluate companies using Discounted Free Cashflow (DFC) and Adjusted Present Value (APV) analysis.
Statement of Changes in Equity
The statement of changes in equity, similarly to the income statement, does not focus on a single date. This statement reports in detail stockholders’ equity and illustrates the changes that occurred in the components of stockholders’ equity across a definite period.
In A Nutshell
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