Understanding Financial Statements

What is a Financial Statement?

A financial statement is a formal record of the financial activities and position of a business, person, or other entity. It includes:

• Income Statement: Provides a summary of a company’s revenues and expenses over a period of time.
• Balance Sheet: Provides a snapshot of a company’s assets, liabilities, and equity at a specific point in time.
• Cash Flow Statement: Shows the cash inflows and outflows from operating, investing, and financing activities over a period of time.

Income Statement

The income statement, also known as the profit and loss statement, shows the company’s revenues and expenses during a specific period. The main components are:

• Total Revenue: The total amount of income generated by the sale of goods or services.
• Cost of Goods Sold (COGS): The direct costs attributable to the production of the goods sold.
• Gross Profit: Total revenue minus the cost of goods sold.
• Operating Expenses: The costs required to run the company’s core operations.
• Operating Income: Gross profit minus operating expenses.
• Net Income: The total profit of the company after all expenses, including taxes and interest, have been deducted.

Balance Sheet

The balance sheet provides a snapshot of the company’s financial position at a specific point in time. It includes:

• Assets: Resources owned by the company (e.g., cash, inventory, property).
• Liabilities: Obligations the company owes to others (e.g., loans, accounts payable).
• Equity: The residual interest in the assets of the company after deducting liabilities.

Cash Flow Statement

The cash flow statement shows the company’s cash inflows and outflows over a period of time. It includes:

• Operating Activities: Cash flows from the company’s core business operations.
• Investing Activities: Cash flows from the purchase and sale of assets.
• Financing Activities: Cash flows from borrowing and repaying loans, issuing and repurchasing stock, and paying dividends.

Why Financial Statements Matter

Financial statements provide critical information for decision-making by:

• Helping investors evaluate the financial health and performance of a company.
• Enabling lenders to assess the creditworthiness of a business.
• Assisting managers in making informed business decisions.