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Introduction to Financial Statements: An Overview


Financial statements refer to a specific set of reports produced in an entity's accounting system. The objective of these reports is to provide information about the entity.

In a Nutshell

A complete set of financial statements includes 5 components:

  1. Statement of Comprehensive Income (income statement plus other comprehensive income) - presents revenues and expenses, and computes net income or loss
  2. Statement of Financial Position (balance sheet) - measures assets, liabilities, and capital
  3. Statement of Changes in Equity - movements affecting the capital balance
  4. Statement of Cash Flows - cash inflow and outflows
  5. Notes to Financial Statements

1. Statement of Comprehensive Income

The Income Statement, also known as Profit and Loss Statement (P&L Statement), shows the results of operations of an entity over a particular period of time. The income statement presents the period's income and expenses and the resulting net income or loss.

Many large companies today prepare a Statement of Comprehensive Income. The Statement of Comprehensive Income presents a company's results of operations (net income or loss) and its other comprehensive income (OCI). If the company has no other comprehensive income, then the contents of the Income Statement and Statement of Comprehensive Income would actually be the same.

Other comprehensive income include gains and losses that cannot be reported in the Income Statement such as revaluation surplus, translation adjustments, and unrealized gains, for a given period. Other comprehensive income is covered in higher financial accounting studies. Income Statement »

2. Statement of Changes in Capital

The Statement of Changes in Capital (or Statement of Changes in Equity) shows the balance of the capital account at the beginning of the period, the changes that occurred during the period, and the ending balance as a result of such changes. Capital is affected by contributions and withdrawals of owners, income, and expenses.

The title used for this report varies depending upon the form of business ownership. It is called Statement of Owner's Equity in sole proprietorships, Statement of Partners' Equity in partnerships and Statement of Stockholders' Equity in corporations. Statement of Owner's Equity »

3. Statement of Financial Position

A Balance Sheet presents an entity's assets, liabilities, and capital as of a given point in time. This report shows the entity's financial position and condition, hence, also called Statement of Financial Position.

All asset amounts are added. All liability and capital accounts are also added. The total amount of assets should be equal to the total amount of liabilities plus capital. Balance Sheet »

4. Statement of Cash Flows

The Statement of Cash Flows, or Cash Flow Statement, presents the beginning balance of cash, the changes that occurred during the period, and the cash balance at the end of the period as a result of the changes.

The cash flow statement shows the cash inflows and outflows from three activities: operating, investing, and financing.

Operating activities pertain to transactions that are directly related to the company's main course of business. Investing activities refer to "where the company puts its money". These activities include long-term investments, acquisition of property, plant and equipment; and other transactions related to non-current assets. Financing activities include transactions in which a company acquires its funds. These include loans from banks (long-term liabilities) and contributions from owners. Cash Flow Statement »

5. Notes to Financial Statements

The Notes to Financial Statements, or Supplementary Notes, provide information in addition to those presented in the Balance Sheet, Income Statement, Statement of Changes in Equity, and Cash Flow Statement. The notes contain disclosures required by accounting standards, supporting computations, breakdown of line items in the face of the financial statements, and other information that users may be interested in.

Relationship among the Financial Statements

The financial statements contain interrelated information. This is the reason the financial statements are prepared in the sequence presented above. In fact, some of the figures in one financial statement component are actually taken from another component.

  1. The net income from the Income Statement is used in the Statement of Changes in Equity. Remember that income and expenses affect capital.
  2. The ending balance of capital in the Statement of Owner's/Partners'/Stockholders' Equity is forwarded to the Balance Sheet.
  3. The cash balance presented in the Balance Sheet is supported by the Statement of Cash Flows. The ending balance of cash in the Statement of Cash Flows is the same amount presented in the Balance Sheet.
  4. The notes to financial statements show supporting computations of the amounts and additional information about the items presented in the above reports.
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