The balance sheet and cash flow statement are two of the three financial statements that companies issue to report their financial performance. The financial statements are used by investors, market analysts, and creditors, to evaluate a company's financial health and earnings potential.
A balance sheet lists a company's assets, liabilities, and shareholders' equity for a period. A balance sheet shows what a company owns in the form of assets, what it owes in the form of liabilities, and the amount of money invested by shareholders listed under shareholders' equity.
The balance sheet shows a company's assets, but also shows how those assets were financed, whether it was through debt or through issuing equity. The balance sheet is broken down into three parts: assets, liabilities, and owners' equity, and it is represented by the following equation:
The equation above must always be in balance. If cash is used to pay down a company's debt, for example, the debt liability account is reduced, and the cash asset account is reduced by the same amount, keeping the balance sheet even. The name "balance sheet" is derived from the way that the three major accounts eventually balance out and equal each other; all assets are listed in one section, and their sum must equal the sum of all liabilities and the shareholders' equity.
Below are examples of items listed on the balance sheet:
- Cash and cash equivalents are liquid assets, which may include Treasury bills and certificates of deposit.
- Marketable securities are equity and debt securities.
- Accounts receivables are the amount of money owed to the company by its customers for product and service sales.
- Inventory is either finished goods or raw materials.
- Shareholders' equity is a company's total assets minus its total liabilities. Shareholders' equity represents the net value or book value of a company. It is the amount of money that would be returned to shareholders if all of the assets were liquidated and all of the company's debt was paid off.
- Retained earnings are recorded under shareholders' equity and are the percentage of net earnings that were not paid to shareholders as dividends. Instead, the money was retained to be reinvested in the business, or pay down debt.
The Cash Flow Statement
The cash flow statement shows the amount of cash and cash equivalents entering and leaving a company.
The cash flow statement (CFS) measures how well a company manages and generates cash to pay its debt obligations and fund operating expenses. The cash flow statement is derived from the income statement by taking net income and deducting or adding the cash from the company's activities shown below.
The three sections of the cash flow statement are:
- Cash from operating activities
- Cash from investing activities
- Cash from financing activities
Operating activities on the CFS include any sources and uses of cash from business activities. In other words, it reflects how much cash is generated from the sale of a company's products or services.
- Receipts from sales of goods and services
- Interest payments
- Income tax payments
- Payments made to suppliers
- Salaries and wages
Investing activities: include any incoming or outgoing cash from a company's long-term investments. Investing activities include:
- A purchase or sale of an asset
- Loans made to vendors or received from customers
- Merger or acquisition payments or credits to cash
Financing activities: include cash from investors or banks, as well as the use of cash to pay shareholders. Financing activities include:
A balance sheet is a summary of the financial balances of a company, while a cash flow statement shows how the changes in the balance sheet accounts and income on the income statement affect a company's cash position. In essence, a company's cash flow statement measures the flow of cash in and out of a business, while a company's balance sheet measures its assets, liabilities, and owners' equity.