Financial statements are formal records of the financial activities of a company. Financial statements typically include three basic financial statements, accompanied by a management discussion and analysis.
THE BALANCE SHEET
The Balance Sheet is a financial statement that is actually a “snapshot” of the company’s health at a given point in time. It shows a company’s Assets, Liabilities, and Equity. The formula for this financial statement looks like this:
Assets = Liabilities + Shareholder’s Equity
The reasoning behind this equation is what the company uses to run its business (assets) must be balanced out by what the company owes (liabilities), and what it owns (equity). Balance sheets are usually updated each quarter.
The assets of a company are divided into two categories:
Current Assets are highly liquid and can be converted into cash in less than a year. They include items such as cash and cash equivalents, accounts receivable, and inventory. All current assets are tangible assets, such as computers, machines, buildings or land, meaning they are assets that have a physical form.
Non-Current Assets take longer than a year to convert into cash. They include tangible assets and intangible assets, such as goodwill, patents, copyrights, and trademarks. Intangible assets cannot be physically seen or touched, but they still have value. For example, the value of a brand name would be included under goodwill.
Liabilities are what the company has borrowed. They can come in two forms:
Current Liabilities - current liabilities that are due within a year. They include short-term loans, accounts payable, and the upcoming interest payments on long-term loans.
Long-Term Liabilities - loans that will become due after more than one year.
Shareholder’s Equity, sometimes called Owner’s Equity or just Equity, is the total amount of money that has been made by the company over its entire lifetime, plus investments and minus dividend payments. It represents the company’s total net worth and must balance with liabilities and assets.
Equity can be negative if the company has lost money over its lifetime.
The Income Statement as a financial statement measures a company’s performance over a specific period of time, usually every quarter and every year. This financial statement describes how much revenue the company made and how much money the company spent to obtain that revenue. The financial statement will show up as either a net profit or a net loss.
Profit (or Net Income) = Revenue – Expenses
The income statement is divided into two parts:
Operating Income is income that came about as part of normal business activities. For example, a company that manufactures clothing would include their revenue and expenses from making clothes as operating income.
Non-Operating income is income that comes from factors outside the company’s normal business activities. This can include expenses related to restructuring, investments, foreign exchange losses, asset write-downs (such as depreciation and amortization), or lawsuits. It can also include money made from dividends, lawsuits, investments, foreign exchange gains, or asset write-ups.
When evaluating an income statement, it is important to look at how much of the company’s profits come from non-operating income. If a significant part of the company’s profits come from actions outside the company’s main area of business, then you should consider using operating income as a guide for how much money the company is likely to make going forward. Financial numbers are often intentionally misstated based on non-operating income.
THE CASH FLOW STATEMENT
The cash flow statement is a financial statement that is similar to the income statement because it tells you how much revenue came into the business and how much cash went out. This financial statement also shows these transactions over a period of time.
The critical difference between these two financial statements is that the cash flow statement tells you when the company is actually receiving their money.
A firm can claim revenue for sales before they have received any of the money. This can become a huge problem for a company that appears to be profitable from the income statement but is not actually receiving any money.
The cash flow statement is broken down into three parts:
Cash Flow from Operating Activities - financial statement that represents the cash flow of companies from their operation like products and services they're selling.
Cash Flow from Investing Activities - this is if the company invests in new technology etc.
Cash Flow from Financing Activities - when a company sells shares or bonds that money shows up here.