A financial statement is a document which summarizes financial data such as income, expenses, or profit/loss. In business, the financial statements definition refers to a group of reports used by a company to monitor its financial status. These statements provide financial details within a specified time period, which is usually one year, but this timeframe can vary. They can help to provide insight to indicate a company's financial position at a given point in time or help to forecast upcoming sales. There are four main types of financial statements that are commonly used in business:
- Income statement
- Statement of retained earnings
- Balance sheet
- Cash flow statement
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Income Statement
The income statement is used to determine whether a profit was made. It provides data about a company's earnings within a specified time period, usually one year. The income statement must include all revenue (the money made by a business through sales or other means within a given period) and all expenses (the costs of the business within that same period). The layout of an income statement typically includes the net sales at the top with deductions of the cost of these sales, as well as operating expenses and non-operating expenses right below it. Operating expenses are those incurred due to running the business, such as employee salaries and conducting market research. Non-operating expenses are those that are not used in the actual operations of the business, but must still be recorded. A common example of this type of non-operating expense is taxes paid by the business.
These figures can be used to calculate the net income, commonly referred to as the bottom line or net earnings, which is the total amount of profit (or loss) the company experienced for a given time period. For example, if the net income is equal to $50,000, this means the company made a profit of $50,000 for that year. The basic formula for calculating net income is:
Net Income = Total Revenue - Total Expenses
Depending on the needs of the business, an income statement may be simple, or it may be more detailed, with income and expenses further broken down into additional categories or lines included on the statement, such as depreciation expenses, amortization, employee wages, or the cost of goods sold (COGS). The income statement may also be comparable to the statement of comprehensive income, which includes net income as well as comprehensive income. Comprehensive income and comprehensive expenses are those pertaining to sources such as retirement accounts or securities, which aren't included on a traditional income statement.
Statement of Retained Earnings
The statement of retained earnings is a financial statement that is used to determine what can be reinvested back into the company. Retained earnings refers to the amount of profit that is left after dividends are paid out to investors and shareholders. It is also commonly referred to as the statement of changes in shareholder's equity. Retained earnings can be calculated using the formula:
Retained Earnings = Beginning Period Balance + Current Net Profit - Cash and Stock Dividends
For example, if a company's beginning period balance equals $50,000, net profit equals $10,000, and dividends paid equals $40,000, then the company would have $20,000 in retained earnings left over to be reinvested.
Balance Sheet
A balance sheet is used by a business to ensure all assets are equal to its liabilities. This statement essentially shows what a business is worth. It consists of two columns: the left side for assets and the right side for liabilities and shareholder's equity. Assets are the things that a business owns, whereas the liabilities are the things a business owes to others. Liabilities may be owed to other businesses, suppliers, lenders, employees, or customers. The left and right sides of the balance sheet must be equal, such that:
Assets = Liabilities + Shareholder's Equity
If a business owns $100,000 in total assets, then its shareholder's equity and liabilities together must also equal $100,000.
Cash Flow Statement
The cash flow statement, or cash flow projection, is used by businesses to determine where their funds are flowing into the business and how they are flowing out of the business. It is useful in determining whether a business is on track to afford its expenses. This statement consists of three parts: operating activities, investing activities, and financing activities.
Operating activities pertains to the cash flow from the operations of the business and analyzes the net income of the business. This is the cash flow that is generated from consumers as products are sold. Investing activities focuses on a company's long-term assets and how they are sold or purchased. For example, if a company purchases a new factory or sells some of its equipment, this would be an investing activity. Financing activities shows the cash flow from activities that pertain to the continued operation of the business, such as selling company stocks and bonds or paying interest on a bank loan.
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