Financial statements refer to reports prepared by companies and released periodically to show their financial position. Conventionally, four types of statements are used as the global standard, and they include: (i) The balance sheet, (ii) Cash flow statements, (iii) The statement of owner’s equity, and (iv) income statement.
These reports are released annually, semi-annually, or each quarter. Companies have economic calendars on which important data release dates, such as earnings release dates, are scheduled and shared with stakeholders.
Financial statements are prepared and reported according to standardized accounting formats, such as GAAP and IFRS. Each report is supposed to be accompanied by a disclosure stating the accounting and reporting formats used to ensure transparency.
Many investors depend on these reports to help them decide how and if to invest in companies.
Analysts also count on them to provide them with valuable information that they can use to make projections on the future performance of companies.
Beyond telling us a company’s financial status, there are several things we can deduce from financial statements. For instance, we can know things like areas of weakness, potential growth frontiers, underperforming segments, etc. The management can use the information to strategize on how to improve performance and reduce losses.
1. Balance sheet
This report is a description of the state of a company’s assets. It gives a breakdown of a company’s total assets, its liabilities, and its shareholders’ equity. The assets may be tangible such as equipment, vehicles, buildings, or intangible, such as the brand value stock and bond investments.
The balance sheet formula is as shown below:
Total Value of Assets = Total Value of Liabilities + Value of Shareholders’ Equity
2. Income statements
The balance sheet gives a highly summarized presentation of a company’s liabilities, its equity, and debt position. However, it doesn’t give a detailed description of their sources. In contrast, an income statement gives a detailed description of the items contained in the balance sheet by showing the actual sources of profits.
Income statements, therefore, enable interested entities like shareholders, investors, and analysts to know the specific market segments that bring financial inflows as well as those responsible for outflows of money.
From an income statement, you can tell how much income came from investments and sales. We can then check the sales figures and assess the impact of expenditures like salaries, rent expenses, water costs, energy bills, cost of raw materials, marketing costs, telephone bills, etc.
Once production costs are deducted from sales, we get the company’s gross profit. Thereafter, we can deduct interest and taxes to obtain the net profit. The figures obtained from the income statement can be used to calculate various financial ratios. This enables investors to understand the extent to which their investment in a company may pay off.
The ratios are used by investors to assess the likelihood of making a profit from a company and the potential profit they can gain by investing in it.
3. Cash flow statement
As you may deduce from the name, this statement tells us the flow of cash into and out of a company. The inflows typically come from sales and investments, while the outflows tell us what money was spent on.
By assessing the difference between inflows and outflows, we can tell whether a company is generating enough cash to sustain its operations and service the debts it may have. Cash Flows are broadly categorized into:
- Investing activities cash flows: These are monies generated from the sales and purchases of a company’s fixed assets.
- Financing activities cash flows: These come from the payment of debts owed as well as from the company’s equity.
- Operations cash flows: This is calculated through the summation of depreciation and non-cash expenses to the difference between the value of assets and liabilities.
4. Statements of equity
This report tells us how much liquid cash a company holds and the value of other capital belonging to the company. Therefore, it tells investors what a company is worth after deducting what it owes to creditors and its shareholders. It is a report of what a company would retain for the period under review, assuming it paid off the debt owed and paying off its shareholders or owners.
They are also among the most scrutinized statements because it outlines how much the company is left with to re-invest into its growth and expansion. Alternatively, some companies can use the retained profits to pay their long-term debts. In addition, investors use statements of equity to determine if a company is stable enough to re-invest into its own growth or if it is likely to source funds through debts.
In summary
The key motivation for doing business is making profits. Financial statements are essential reports that tell stakeholders how a company is and helps them evaluate its suitability performing as an investment destination.
The four statements discussed above should always be part of your toolkit for investment decision-making. However, for you to understand how they are compiled, you need to research further on their core components. In addition, you should understand how each of these components translates into profitability or loss-making for a company.
