Written by Financial Statements are formal records of the financial activities of a business, entity or other persons.
They are written reports that quantify a company’s financial strength, performance, liquidity, and cash flows.
Financial Statements reflect the financial effects of business transactions and events on the entity.
Four Types of Financial Statements
Financial statements are divided into four categories: statement of financial position, income statement, statement of cash flow and statement of changes in equity.
Statement of Financial Position
The statement of Financial position shows the company’s total assets, and how these assets are financed, through either debt or equity.
It reflects the company’s financial position at a specific point in time.
The Statement of financial position is also known as a balance sheet.
The statement of financial position consists of three major items: assets, liabilities and equities.
Assets
An asset is an economic resource owned or controlled by a business due to a past event which is expected to provide future benefits to the firm.
It consists of anything a business owns or controls that can be quantified in monetary terms (e.g. cash, inventory, plant and machinery, etc)
Assets can be divided into tangible and intangible assets.
- Intangible assets: These are non-physical assets that cannot be seen or touched but are nonetheless valuable because they represent potential future benefits. Simply put, intangible assets cannot be touched. Examples are goodwill, copyrights, patents etc.
- Tangible assets: These are physical and measurable assets that can be seen and touched. Tangible assets are either short-lived or long-lived assets that are held for the purpose of generating revenue. Plants, equipment, computers, cash, machinery, and inventories are examples of tangible assets.
Assets can also be divided into current and non-current assets.
- Current assets: Current assets include cash and other liquid assets which a business expects to convert to cash within twelve months of reporting. They are assets that are expected to be sold, consumed, or converted into cash within one year or within the business’s normal operating cycle, whichever is longer. Among the better-known current assets are cash, trade receivables, account receivables, note receivable, prepaid expenses and inventory.
- Non-current assets: Non-current assets are assets that are expected to be converted to cash during the next twelve months. Non-current assets last for a long period, and are, therefore, called long term assets. Examples are plant, machinery, equipment etc.
Liabilities
Liabilities are obligations of the company arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services, or other yielding of economic benefits in the future
They include everything that a business owes to third parties and can be in the form of creditors, bank loans, etc
Liabilities can be divided into current and non-current liabilities.
- Current liabilities: These are short-term debt obligations to be settled within an accounting period. Examples are accrued expenses, unearned revenue, trade payables, and bills payable.
- Non-current liabilities: These are long-term debt obligations that are not expected to be settled within the next twelve months. Examples are bank loans and debentures etc.
Equity
The total amount owed by the company to its owner (s) is called equity.
Equity can also refer to the amount of capital that remains in the business after all its assets have been used to pay off its outstanding liabilities.
Stated differently, equity is the difference between assets and liabilities.
The objective for preparing the statement of financial position is to ensure that assets equal the sum of liabilities and equities, as per the accounting equation
It is vital to note that the balance sheet accounts are not closed at the end of an accounting period.
For this reason, balance sheet accounts are also referred to as permanent or real accounts.
Income Statement
Also known as the Profit and Loss Statement, the Income statement reports the company’s financial performance in terms of net profit or loss over a specified period.
The income statement is also known as the statement of financial performance, statement of operation or statement of activities.
The income statement is essentially a summarised report of the revenues and expenses of an entity for a particular accounting year.
The income statement is made up of two components: income and expenses.
Income
Income is the total receipts that a business has earned over a period. Examples are sales revenue and commissions earned
Expenses
This is the total cost incurred by the business in generating income for a given period.
Examples are salaries and wages, depreciation charges, and rental charges.
At the end of the accounting period, the balance of income statement accounts (income and expense accounts) is normally closed.
As a result, income statement accounts are referred to as temporary or nominal accounts.
The objective of preparing an income statement is to determine a company’s net profit or loss for a given period by subtracting expenses from income.
Cash Flow Statement
The Cash Flow Statement (or statement of cash flows) shows the movement in cash and bank balances over a period.
The statement of cash flows summarizes a company’s cash inflows and outflows over a specific period.
The statement of cash flow is divided into 3 segments: operating activities, investing activities, financing activities
Operating Activities of cash flow statement
This represents the cash flow from the primary activities of a business.
It is the segment of the cash flow statement where sales, purchases and other cash flows relating to the primary income-generating activities of an entity are recorded.
Investing Activities of cash flow statement
This represents cash flow relating to purchasing and selling non-current assets such as machinery and equipment.
Investing-related cash outflows are normally classified as capital expenditure.
Financing activities of cash flow statement
This is the cash flow that is created or spent on raising and repaying share capital and debt, as well as interest and dividend payments.
Financing activities cash flows usually result in changes in the capital structure of a business.
The purpose of preparing the statement of cash flow is to reconcile the change in the cash and cash equivalent balances as reflected on the balance sheet.
To put it another way, statement of cash flow is prepared to show why the cash balance of a company has changed from one period to another
Statement of Changes in Equity
Also known as the Statement of Retained Earnings, the statement of changes in equity shows the movement in owners’ equity over a period.
It is mainly a reconciliation of the beginning and ending balances in the equity of a company over a certain period.
The statement of changes in equity covers the following:
1. Net profit or loss during the period as shown in the income statement
2. Share capital issued or repaid during the accounting year.
3. Dividend payments
4. Accumulated reserves and retained earnings
5. Effects of a change in accounting policy or correction of an accounting error
The main objective of preparing the statement of changes in equity is to reconcile the changes in the equity of a business.
It should be mentioned here that the statement of retained earnings is the least used financial statement.
