A Beginner’s Guide to the 4 Financial Statements

The financial press and television devote seemingly endless coverage to headline events pertaining to large public corporations. Public companies are those with securities that are readily available for purchase/sale through organized stock markets. Many more companies are private, meaning their stock and debt is in the hands of a narrow group of investors and banks. The financial records of your business are important to you and your investors. When packaged together in the form of financial statements, they provide information on the health of your business.

Generally Accepted Accounting Principles (GAAP) are the set of rules by which United States companies must prepare their financial statements. It is the guidelines that explain how to record transactions, when to recognize revenue, and when expenses must be recognized. International companies may use a similar but different set of rules called International Financial Reporting Standards (IFRS). It provides insight into how much and how a business generates revenues, what the cost of doing business is, how efficiently it manages its cash, and what its assets and liabilities are. Financial statements provide all the detail on how well or poorly a company manages itself. Although financial statements provide a wealth of information on a company, they do have limitations.

Accounting: Art, Not Science

The statement of retained earnings is not usually as rigorously tracked as the previous three statements. Investors need an accurate picture of what you are doing with your profits. They also need to know what activities you are undertaking to generate high returns to shareholders. Any items within the financial statements that are valuated by estimation are part of the notes if a substantial difference exists between the amount of the estimate previously reported and the actual result.

Four Basic Financial Statements

A company’s financial statements can give you a much better idea of how a business is performing than by simply looking at its revenue and earnings. The cash flow statement shows how a company’s liquid https://quickbooks-payroll.org/ assets are increasing or decreasing over time. Positive cash flow indicates that more money is flowing in than out, and can be an indicator of improving financial strength and flexibility.

Primary Expenses

In the example below, ExxonMobil has over $2 billion of net unrecognized income. Instead of reporting just $23.5 billion of net income, ExxonMobil reports nearly $26 billion of total income when considering other comprehensive income. Below is a portion of ExxonMobil Corporation’s income statement for fiscal year 2021, reported as of Dec. 31, 2021. Primary expenses are incurred during the process of earning revenue from the primary activity of the business. Expenses include the cost of goods sold (COGS), selling, general and administrative expenses (SG&A), depreciation or amortization, and research and development (R&D). This is the income earned from other activities, such as gains from the sale of long-term assets including vehicles, land, or a subsidiary.

The numbers in a company’s financial statements reflect the company’s business, products, services, and macro-fundamental events. These numbers and the financial ratios or indicators derived from them are easier to understand if you can visualize the underlying realities of the fundamentals driving the quantitative information. For example, before you start crunching numbers, it’s critical to develop an understanding of what the company does, its products and/or services, and the industry in which it operates. Finally, it is important to note that the income statement, statement of retained earnings, and balance sheet articulate. The income for the period ties into the statement of retained earnings, and the ending retained earnings ties into the balance sheet.

Understanding Financial Statements

In another instance, if an enterprise raises additional share capital, this will induce modification of its Statement of Owners’ Equity and Statement of Financial Position concurrently. It may almost seem magical that all line items eventually mesh together and balance. Typically, the Statement of Comprehensive Income is prepared on an annual basis. However, most publicly-traded companies produce a Profit & Loss Statement quarterly or for a 6-month period. In general, it has two primary elements— the Income Statement and the Statement of Other Comprehensive Income. The difference between Assets and Liabilities is sometimes referred to as net assets or net worth.

  • The income statement is also used to evaluate the financial performance of the business.
  • An income statement, also known as a profit and loss (P&L) statement, shows you your business’s profits and losses over a certain period of time.
  • GAAP sets accounting guidelines and standards that companies must follow when preparing financial statements, whereas IFRS takes a more principles-based approach.
  • Maxidrive’s total earnings (or losses incurred) less all dividends paid to the stockholders since formation of the corporation equaled $9,105,000 and is reported as retained earnings.
  • At its core, it tracks how your business’ net revenue is translated into earnings.

The subsequent Edelweiss examples were representative of “vertical” balance sheet arrangements. The financial statements are used by investors, market analysts, and creditors to evaluate a company’s financial health and earnings potential. The three major financial statement reports are the balance sheet, income statement, and statement of cash flows. The income statement shows your sales revenue, operating expenses and net income for a specific time period, according to Corporate Finance Institute. The amount of your cash sales is included with the cash account on the balance sheet and are listed on the statement of cash flows.

When Maxidrive sells its disk drives to Dell and others, it sells them on credit and receives promises to pay called accounts receivable, which are collected in cash later. The income statement presents the revenues, expenses, and profits/losses generated during the reporting period. This is usually considered the most important of the financial statements, since it presents the operating results of an entity. It’s management’s opportunity to tell investors what the financial statements show and do not show, as well as important trends and risks that have shaped the past or are reasonably likely to shape the company’s future. The statement of retained earnings also referred to as the statement of owners’ equity, is a financial report that details what portion of a company’s profits have been kept over a given period.

  • The operating portion shows cash received from making sales as part of the company’s operations during that period.
  • Each type of financial statement gives you insight into different information.
  • They can tell you what business decisions have been made and which aspects of the operations are worth investigating in more detail.
  • Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent.
  • Bankers often consider the Operating Activities section to be most important because it indicates the company’s ability to generate cash from sales to meet its current cash needs.
  • Knowing how to work with the numbers in a company’s financial statements is an essential skill for stock investors.

Your financial statements list things like your expenses and income as well as transaction totals. Each type of financial statement gives you insight into different information. If you’re a small business owner, you know how important it is to keep your financial information in order. But to keep your finances organized, you have to know about the Four Basic Financial Statements and how you can use them to grow your small business. We all remember Cuba Gooding Jr.’s immortal line from the movie Jerry Maguire, “Show me the money! They show you where a company’s money came from, where it went, and where it is now.


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