Businesses produce a set of financial statements that reflect business activities, revenues and expenses for each accounting period. The three main financial statements are the balance sheet, income statement, and statement of cash flows. The cash flow statement simply shows the company’s cash activities, the balance sheet illustrates a company’s book value, and the income statement shows how assets and liabilities are used.

The balance sheet shows the company’s assets, liabilities and shareholder equity. The basic accounting formula Assets = Liabilities + Shareholder Equity provides the structure for the statement. Assets are listed first in order of liquidity, including cash, short-term investments, accounts receivable, notes receivable, inventory, and prepaid expenses. Next, long-term assets such as investments, fixed assets such as real property, other assets, and intangible assets are listed. The sum of all assets should equal the following section of the balance sheet, which lists all liabilities in order of maturity and shareholders’ equity. Investors need all of this information to determine the current value of the company.

The income statement, like the balance sheet, helps to illustrate the current value of a business. Revenues and expenses are listed on the income statement as they are accrued and categorized as operating or non-operating activities. First, sales are matched with cost of goods sold to determine gross profit. Next, operating expenses are deducted to reveal operating profit. From this point, any nonoperating revenues and expenses are listed, generating earnings before interest, taxes and amortization EBITA. Taxes are then deducted to reveal the net income. Shareholder distributions are typically made using this final sum, so investors watch it closely. Investors and analysts also pay close attention to the operating section of the income statement to gauge how efficiently management operates the main activities for the company.

Both statements are closely scrutinized by investors and stakeholders as they provide a strong indication of the current health and future prospects of any company.

Let's explore financial statements some more - Read Accounting Basics: Financial Statements, Advanced Financial Statement Analysis, and Fundamental Analysis: Introduction to Financial Statements.

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