Financial statements are an important aspect of every business. It is a mirror that reflects the fair view of the financial performance and position of the organization. Financial statements help in the comparison between the financial strength of an organization with the previous years. The main users of financial statements are shareholders, financial analysts, creditors, bankers, debenture holders, Government, and all other stakeholders of a business.
All organizations that have financial transactions need to prepare a financial statement, whether they are for-profit or not for profit. An important part of the annual report of a company, financial statements could be presented in different forms. There are five types of financial statements that form part of an annual report. Let us discuss them in detail.
1. Income statement
An income statement is prepared for a certain period and not for a specific date. This is the main difference between the income statement and a balance sheet.
The statement will show the calculation of income over a period of time. It includes sales, taxes, operating costs, interest cost, depreciation, net income, dividends, and more. The statement begins with the net sales and all expenses are deducted to derive the net income.
When financial statements are being prepared, one has to begin with an income statement. The cash and bank balance in the income statement will be reflected in the balance sheet under current assets.
2. Balance sheet
As the term suggests, a balance sheet is a tabular sheet of balance displaying assets, equity, and liabilities. Assets can be divided into current assets and property, equipment, and plant.
Equities can be common stock, preferred stock, and retained earnings. Liabilities are classified into long-term and short-term liabilities. Every line item on the balance sheet holds significance.
It is nothing but a set of balances at the end of the financial year. The date for the presentation of a balance sheet for an annual report is the last date of the financial year, which is December 31 every year. Several organizations display balances of the previous year to facilitate comparison.
3. Statement of cash flows
Net cash flow holds significant importance in the calculation of the intrinsic value of the business. This is whey cash generation has more value than income reported in the financial statements.
The real source of value creation is cash and not just income as shown in the statement.
Many investors consider the statement of cash flow as an important statement to consider before investing in an organization. The cash flow statement will reflect on how strong an organization is in terms of liquidity.
A statement of cash flow is a statement of cash generation and cash utilization. It shows how the cash was owned by the company and how it was utilized by it. It is categorized under different activities as follows:
- Operating activity
- Investing activity
- Financing activity.
The cash balance at the end of the period and the net income will be different for several reasons like changes in working capital, non-cash adjustment to net income, payment of dividend, and investment.
4. Statement of shareholders equity
The Statement of shareholders’ equity shows the capital investment by the stockholders and the retained earnings of the company. It is presented on a particular date and is usually presented with the Balance sheet.
There are two parts to the statement which include a common stock statement and a retained earnings statement.
The statement shows the number of shareholders of the organization and the divided paid to equity and preferred shares holders during the year.
5. Notes to financial statements
The last and final part of the financial statement is notes to the statements. It is one of the most important statement but many forget about it. A mandatory requirement by IFRS, the notes to the financial statement are used to disclose all information that is important for the financial statements.
It gives a better understanding to the users. The notes are related to specific accounts and provide information on how a particular figure was derived.
For example, in the balance sheet, there will be a balance of fixed assets but the detailed information about the depreciation and amortization will be shown in the notes.
You will also be able to understand how a particular figure was arrived at. Notes are crucial for readers of financial statements. Footnotes are also an important part of financial statements and they speak about the contingent liabilities, inventory method, and more.
Financial statements of any organization are incomplete if they do not have these five statements. Every statement serves a different purpose and has a specific method of preparation. A thorough reading and understanding of the statements can give you an insight into the profitability of the company.