What are Financial Statements?
Financial Statements are structured reports that summarize a company’s financial performance, position, and cash flows over specified periods. The three primary statements are:
- Income Statement: Shows revenues, expenses, and net income for a period.
- Balance Sheet: Presents assets, liabilities, and equity at a point in time.
- Cash Flow Statement: Details cash inflows and outflows from operating, investing, and financing activities.
Why are Financial Statements Important?
Financial Statements are crucial because they:
- Inform Stakeholders: Provide investors, lenders, and management with transparent data on profitability, liquidity, and solvency.
- Support Decision-Making: Guide strategic planning, investment analysis, and risk assessment.
- Ensure Compliance: Meet regulatory and accounting standards (GAAP, IFRS) for accurate and consistent reporting.
How are Financial Statements Prepared?
Preparation involves:
- Recording Transactions: Using double-entry bookkeeping to capture every financial event in journals and ledgers.
- Adjusting Entries: Making accruals, deferrals, and estimates to align revenues and expenses with the correct period.
- Compilation: Summarizing adjusted balances into trial balances and then into the three primary financial statements.
- Disclosure: Adding notes that explain accounting policies, assumptions, and significant events.
Additional Considerations
- Interrelated Nature: Changes in one statement (e.g., net income on the Income Statement) flow through to the others (retained earnings on the Balance Sheet and Operating Cash Flow).
- Comparability: Consistent application of accounting methods is essential for period-over-period and peer comparisons.
- Audit and Assurance: Independent audits provide credibility and validation of the financial statements’ accuracy and fairness.
Income StatementThe Income Statement (Profit & Loss Statement) summarizes a company’s revenues, expenses, and profits or losses over a reporting period, reflecting operational performance.
Balance SheetThe Balance Sheet is a snapshot of a company’s financial position at a specific date, detailing its assets, liabilities, and equity, and illustrating the accounting equation: Assets = Liabilities + Equity.
Cashflow StatementThe Cash Flow Statement reports a company’s cash inflows and outflows over a period, classified into operating, investing, and financing activities, illustrating liquidity and cash management.