Financial statements are essentially the report cards for businesses. They tell the story, in numbers, about the financial health of the business.
Financial Statement Essentials
How are financial statements connected to each other?
The information found on the financial statements of an organization is the foundation of corporate accounting. Data found in the balance sheet, the income statement, and the cash flow statement is used to calculate important financial ratios that provide insight on the company’s financial performance. The income statement provides deep insight into the core operating activities that generate earnings for the firm. The balance sheet and cash flow statement, however, focus more on the capital management of the firm in terms of both assets and structure.
What’s the difference between a cash flow statement and an income statement?
The cash flow statement and the income statement are two of the main financial statements. The cash flow statement is linked to the income statement by net profit or net loss, which is usually the first line item of a cash flow statement, used to calculate cash flow from operations. A cash flow statement shows the exact amount of a company's cash inflows and outflows over a period of time. The income statement is the most common financial statement and shows a company's revenues and total expenses, including noncash accounting, such as depreciation over a period of time.
Do dividends go on the balance sheet?
There is no separate balance sheet account for dividends after they are paid. However, after the dividend declaration but before actual payment, the company records a liability to shareholders in the dividends payable account. After cash dividends are paid, the company's balance sheet does not have any accounts associated with dividends. However, the company's balance sheet size is reduced, as its assets and equity are reduced.Learn More: Dividends and the Balance Sheet
Why do shareholders need financial statements?
Financial statements are essential since they provide information about a company's revenue, expenses, profitability, and debt. Shareholders need financial statements to make informed decisions about their equity investments, especially when it comes time to vote on corporate matters. There is no one indicator that can adequately assess a company's financial position and potential growth, which is why important metrics (along with many others) are calculated using the figures released by a company on its financial statements.Learn More: Why Shareholders Need Financial Statements
Does the balance sheet always balance?
A balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities and shareholders' equity every time. The assets on the balance sheet consist of what a company owns or will receive in the future and which are measurable. The major reason that a balance sheet balances is the accounting principle of double entry. This accounting system records all transactions in at least two different accounts, and therefore also acts as a check to make sure the entries are consistent. If the balance sheet you're working on does not balance, it's an indication that there's a problem with one or more of the accounting entries.Learn More: Balancing the Balance Sheet
Cash Flow from Operating Activities
Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers. It is the first section depicted on a company's cash flow statement. CFO focuses only on the core business, and is also known as operating cash flow (OCF) or net cash from operating activities.
Financial Statement Analysis
Financial statement analysis is the process of analyzing a company's financial statements for decision-making purposes. External stakeholders use it to understand the overall health of an organization as well as to evaluate financial performance and business value. Companies use the balance sheet, income statement, and cash flow statement to provide transparency to their stakeholders. All three statements are interconnected and create different views of a company’s activities and performance.
Revenue is money brought into a company by its business activities. It is the top line (or gross income) figure from which costs are subtracted to determine net income. Revenue is also known as sales on the income statement. There are different ways to calculate revenue, depending on the accounting method employed.
Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services. Gross profit will appear on a company's income statement and can be calculated by subtracting the cost of goods sold (COGS) from revenue (sales). These figures can be found on a company's income statement.
Gross income for an individual—also known as gross pay when it’s on a paycheck—is an individual’s total earnings before taxes or other deductions. This includes income from all sources, not just employment, and is not limited to income received in cash; it also includes property or services received. For companies, gross income is interchangeable with gross margin or gross profit. A company’s gross income, found on the income statement, is the revenue from all sources minus the firm’s cost of goods sold (COGS).
Accounts payable (AP) are amounts due to vendors or suppliers for goods or services received that have not yet been paid for. The sum of all outstanding amounts owed to vendors is shown as the accounts payable balance on the company's balance sheet. The increase or decrease in total AP from the prior period appears on the cash flow statement.