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Three important financial statements

Three important financial statements

You’ll learn about three important financial statements used for reporting a company's financial performance over a specific accounting period.

Three important financial statements.

- Income statement

- Balance sheet

- Cash Flow statement

What is an Income Statement?

Also known as the profit and loss statement (P&L)or the statement of revenue and expense, the income statement primarily focuses on the company’s revenues and expenses during a particular period.

* An income statement is one of the three (along with balance sheet and statement of cash flows) major financial statements that reports a company's financial performance over a specific accounting period.

* Net Income = (Total Revenue + Gains) – (Total Expenses + Losses)

* Total revenue is the sum of both operating and non-operating revenues while total expenses include those incurred by primary and secondary activities.

* Revenues are not receipts. Revenue is earned and reported on the income statement. Receipts (cash received or paid out) are not.

* An income statement provides valuable insights into a company’s operations, the efficiency of its management, under-performing sectors and its performance relative to industry peers.

The income statement is an important part of a company’s performance reports that must be submitted to the Securities and Exchange Commission (SEC)

The income statement reports income through a particular time period and its heading indicates the duration, which may read as “For the (fiscal) year/quarter ended September 30, 2018.”

The income statement focuses on four key items—revenue, expenses, gains, and losses. It does not differentiate between cash and non-cash receipts (sales in cash versus sales on credit) or the cash versus non-cash payments/disbursements (purchases in cash versus purchases on credit). It starts with the details of sales, and then works down to compute the net income and eventually the earnings per share (EPS). Essentially, it gives an account of how the net revenue realized by the company gets transformed into net earnings (profit or loss).

The following are covered in the income statement, though its format may vary depending upon the local regulatory requirements, the diversified scope of the business and the associated operating activities:

Operating Revenue

Revenue realized through primary activities is often referred to as operating revenue.

Non-Operating Revenue

Revenues realized through secondary, non-core business activities are often referred to as non-operating recurring revenues.

Gains

Also called other income, gains indicate the net money made from other activities, like the sale of long-term assets.

Expenses and Losses

The cost for a business to continue operation and turn a profit is known as an expense. Some of these expenses may be written off on a tax return if they meet the IRS guidelines.

Primary Activity Expenses

All expenses incurred for earning the normal operating revenue linked to the primary activity of the business. They include the cost of goods sold (COGS), selling, general and administrative expenses (SG&A), depreciation or amortization, and research and development (R&D) expenses. Typical items that make up the list are employee wages, sales commissions, and expenses for utilities like electricity and transportation.

Secondary Activity Expenses

All expenses linked to non-core business activities, like interest paid on loan money.

Losses as Expenses

All expenses that go towards a loss-making sale of long-term assets, one-time or any other unusual costs, or expenses towards lawsuits.

Income Statement Structure

Mathematically, the Net Income is calculated based on the following:

Net Income = (Revenue + Gains) – (Expenses + Losses)

Uses of Income Statements

Though the main purpose of an income statement is to convey details of profitability and business activities of the company to the stakeholders, it also provides detailed insights into the company’s internals for comparison across different businesses and sectors. Such statements are also prepared more frequently at the department- and segment-levels to gain deeper insights by the company management for checking the progress of various operations throughout the year, though such interim reports may remain internal to the company.

Based on income statements, management can make decisions like expanding to new geographies, pushing sales, increasing production capacity, increased utilization or outright sale of assets, or shutting down a department or product line. Competitors may also use them to gain insights about the success parameters of a company and focus areas as increasing R&D spends.

Creditors may find limited use of income statements as they are more concerned about a company’s future cash flows, instead of its past profitability. Research analysts use the income statement to compare year-on-year and quarter-on-quarter performance. One can infer whether a company's efforts in reducing the cost of sales helped it improve profits over time, or whether the management managed to keep a tab on operating expenses without compromising on profitability.

What Is a Balance Sheet?

the balance sheet is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders.

Balance sheets can be used with other important financial statements to conduct fundamental analysis or calculating financial ratios.

* A balance sheet is a financial statement that reports a company's assets, liabilities, and shareholder equity.

* The balance sheet is one of the three core financial statements that are used to evaluate a business.

* It provides a snapshot of a company's finances (what it owns and owes) as of the date of publication.

* The balance sheet adheres to an equation that equates assets with the sum of liabilities and shareholder equity.

* Fundamental analysts use balance sheets to calculate financial ratios.

Components of a Balance Sheet

Assets

Accounts within this segment are listed from top to bottom in order of their liquidity. This is the ease with which they can be converted into cash. They are divided into current assets, which can be converted to cash in one year or less; and non-current or long-term assets, which cannot.

Liabilities

A liability is any money that a company owes to outside parties, from bills it has to pay to suppliers to interest on bonds issued to creditors to rent, utilities and salaries. Current liabilities are due within one year and are listed in order of their due date. Long-term liabilities, on the other hand, are due at any point after one year.

Shareholder Equity

Shareholder equity is the money attributable to the owners of a business or its shareholders. It is also known as net assets since it is equivalent to the total assets of a company minus its liabilities or the debt it owes to non-shareholders.

Retained earnings are the net earnings a company either reinvests in the business or uses to pay off debt. The remaining amount is distributed to shareholders in the form of dividends.

What Is Included in the Balance Sheet?

The balance sheet is an essential tool used by executives, investors, analysts, and regulators to understand the current financial health of a business. It is generally used alongside the two other types of financial statements: the income statement and the cash flow statement.

Who Prepares the Balance Sheet?

Depending on the company, different parties may be responsible for preparing the balance sheet. For small privately-held businesses, the balance sheet might be prepared by the owner or by a company bookkeeper. For mid-size private firms, they might be prepared internally and then looked over by an external accountant.

What Is a Cash Flow Statement?

A cash flow statement is a financial statement that provides aggregate data regarding all cash inflows a company receives from its ongoing operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period. 

* A cash flow statement provides data regarding all cash inflows a company receives from its ongoing operations and external investment sources.

* The cash flow statement includes cash made by the business through operations, investment, and financing—the sum of which is called net cash flow.

* The first section of the cash flow statement is cash flow from operations, which includes transactions from all operational business activities. 

* Cash flow from investment is the second section of the cash flow statement, and is the result of investment gains and losses. 

* Cash flow from financing is the final section, which provides an overview of cash used from debt and equity.

Important

Investors and analysts should use good judgment when evaluating changes to working capital, as some companies may try to boost up their cash flow before reporting periods.

When the cash flow from financing is a positive number, it means there is more money coming into the company than flowing out. When the number is negative, it may mean the company is paying off debt, or is making dividend payments and/or stock buybacks.

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