What Are Financial Statements?
Financial statements are formal records that capture a business’s activities over a certain period. They provide a snapshot of the financial health of your business and are an essential part of any accounting toolkit. Financial statements have been used throughout history, dating back to the dawn of civilization in Ancient Mesopotamia, with the recognizable financial statement, the balance sheet, being traced to the late Middle Ages. Financial Statements have shown their enduring importance to business owners throughout history.
In this article, we will explore the three main types of financial statements: (1) Balance Sheets, (2) Income Statements, and (3) Cash Flow Statements.
Why Do We Use Financial Statements?
Financial statements allow transparent disclosure of your business’s financial activity. To ensure they accurately represent the reality of your business, they must strictly adhere to established accounting principles and fair presentation standards.
These statements, as reflections of specific periods, can help you identify trends and patterns, making them indispensable tools for financial planning. Additionally, financial institutions, such as banks and investors, often rely on financial statements to evaluate the health of your business, particularly when determining loan status or other financial decisions. When prepared by a CPA, financial statements lend credibility and reliability to your financial reporting, often required by institutions and investors.
Income Statements
Income statements reflect your business’s profitability and operational efficiency. In short, they show how much money your business made compared to how much it spent over a given period.
An income statement breaks down into three main components:
Net Income is the profit (or loss) left once all revenues and expenses are accounted for.
Revenue – This is the money your business earns and is usually divided into operating revenue (from selling goods or services) and non-operating revenue (from external sources like interest on savings).
Expenses are the costs incurred in selling goods or services, including essential costs and those external to your business operations.
Balance Sheet
A balance sheet shows what your business owns and owes at the end of a given period. It includes three key elements:
1. Assets are resources owned by the business expected to contribute to revenue generation.
2. Liabilities are the obligations or debts your business must eventually repay.
3. Shareholder Equity reflects the money you or other shareholders invest into the business.
The balance sheet follows the formula: Assets = Liabilities + Shareholder Equity,
ensuring the total value of your asset’s balances with your liabilities and shareholder equity—hence the term “balance sheet.”
Cash Flow Statement
Essentially, a cash flow statement tracks the movement of money in and out of your business. Income statements tend to view Income as static and fully accessible. However, reality tends to be more complex due to your business’ unique spending and earning cycles. Thus, only a portion of your Income may be available at any given time.
A cash flow statement helps you monitor these cycles to ensure you have enough cash to cover expenses and meet obligations when they arise.
Conclusion
Financial statements are an essential tool in your accounting toolkit. Each type serves a distinct function, helping you better understand and manage your business’s financial health. However, preparing financial statements can be complex and requires a thorough understanding of accounting principles. At VN Accounting, we specialize in preparing financial statements, guiding you through their interpretation, and assisting you in planning for the future. We can also ensure that your business’s financial statements are prepared faithfully and accurately to reflect the reality of your business activity, thus lending the professional credibility that institutions and investors require.
