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Finance 101: The 3 Basic Financial Statements

The 3 Basic Financial Statements

What is a Financial Statement?

Financial Statements – or Financial reports – are a formal, written record of the business and financial activities of an individual or an organisation. These records should be in a structured, easy to understand form as they often need to be audited by accountants, tax firms, government agencies or potential investors.

The three basic Financial Statements are;

 

  • A Balance Sheet
  • An Income Statement
  • A Cash Flow Statement

 

Financial Statement #1: Balance Sheets

A Balance Sheet reflects an individual or organisation’s liabilities, assets and equity at a single point in time. This Financial Statement is either in account form or report form, depending on the requirements. A balance sheet shows a snapshot of a company’s Net Worth at that time and is calculated as Assets – Liabilities. In the most simplistic form, it is shown with Assets on the left column and Liabilities and owners equity on the right column. Best practice is to list the Assess in order of liquidity. The two columns need to ‘match’, or ‘balance’ and the simplest formula used is below;

Assets = (Liabilities + Owners Equity)

Current Assets can be converted into cash easily, and are are classified as;

 

  • Cash and cash equivalent
  • Accounts receivables
  • Pre-paid expenses for services that will be used within the year
  • Accrued revenue (services rendered that are yet unpaid)
  • Money lent to (less than one financial period)
  • Inventory

Non-current Assets or Fixed assets are difficult to convert into cash quickly, and are classified as;

 

  • Real estate and property
  • Intangible assets such as copyrights, trademarks, patents and other intellectual property
  • Biological assets such as livestock, orchard trees, plants etc.
  • Equity method Investments (associate companies, joint ventures etc.)
  • Money lent to (over one financial period)

Liabilities are classified as;

 

  • Current and deferred tax requirements
  • Loan interests on debts due
  • Accounts payables
  • Unearned revenue for services owed to customers who have paid in advance
  • Financial liabilities such as corporate bonds or promissory notes
  • Employee dues; salaries, gratuities, pension funds
  • Shareholders equity (See below)

Equity, also known as Capital are classified as;

 

  • Shareholders equity (money owed to shareholders)
  • Issued capital
  • Capital reserves attributed to controlling investors

 

Financial Statement #2: Income Statements

There are multiple names for an Income Statement – Profit and Loss Statement, Statement of Earnings, Operating Statement and Revenue Statement. Regardless of what it is called, its core function is to provide an overview of expenses, revenues, earnings per share and net income of an individual or organisation over a range of time. The statement shows if the entity made a profit or loss over a specific financial period and is used to calculate Net income using the following formula;

Net Income = (Revenue – Expenses)

Income statements can either be in a Single Step format or Multi-Step format. Single Step statements subtracts total expenses from total revenues to find the bottom line. The Multi-Step format follows the below steps;

 

  • Calculate gross profit
  • Calculate operating expenses
  • Calculate Income from operations by deducting operating expenses from gross profit
  • Calculate Income before Taxes by deducting all remaining expenses (foreign exchange loss etc.) from other revenues (rent, interest earned from bank savings etc.)
  • Finally, deduct taxes to produce Net Income.

 

Financial Statement #3: Cash Flow Statements

A Cash Flow Statement complements the Income Statement and Balance Sheet as it depicts the impact of both statements on cash and cash equivalents. Also called a Statement of Cash Flows, it deals with the flow of cash in and out of an organisation. Cash analysis is often broken down to investing, operating and financing activities in a company.

Cash Flow Statements are an important tool in to determine the short-term viability of a business. This is especially important in relation to an organisation’s ability to pay its bills and debts, as it’s a measure of how well the organisation has generated cash to meet its obligations, fund future investments and cover operating expenses.

The Cash Flow Statement is viewed by;

 

  • Company Shareholders
  • Potential investors
  • Potential creditors or lenders
  • Financial accountants
  • Company Directors to help make decisions

 

 

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