What are financial Statements

What are financial statements?

Financial statements are written records that share information about business activities and financial information of a company. Financial statements are created every year or at the end of the fiscal year of a company. These financial statements are made for reviewing the company's financial activities. Financial statements are audited by government agencies, accounting firms, investors, internal users, and others.

There are five main types of financial statements. They are: 

1. Statements of financial position

2. Statements of profit or loss or comprehensive income

3. Statements of cash flows

4. Statements of changes in Equity

5. Notes to the financial positions. 

Here we'll discuss all of the financial statements step by step. 

1. What are statements of profit or loss or comprehensive income?

Statements of profit or loss or comprehensive income are prepared to find out one company's profit or loss after deducting all types of expenses during the fiscal year. After the end of the fiscal year, what are the conditions of a company? Is it profitable or not for the investor or internal user? So, an income statement consists of all kinds of income, and from that income, subtract all kinds of expenses. A statement of profit or loss or comprehensive income is essential for business, as are other financial statements. Statements of profit or loss or comprehensive income are consistent with a business's all types of income and expenditures. There are various sources of income for a business, but the main source of income depends on the business's nature, whether the business is selling goods or services. For example, a manufacturing business's main source of income is from selling goods rather than its income. There are also many sources of expenditure; those that are directly related to selling goods are called the cost of goods sold. 

There are other types of costs named operating expenses, administrative expenses, and selling and marketing expenses, which are subcategories of operating expenses. Operating expenses consist of all types of operational expenses that are related to a business's operation in terms of generating profit. 

For a business at the end of the fiscaller it's important to find out whether the business is in profit or loss, and that's why we need to calculate profit and loss. To prepare the statement of profit or loss or other comprehensive income, we need to accumulate all sources of income and after that subtract all types of expenditures from income. When you are going to subtract the cost of goods sold from income, you will find the business's gross profit or loss. From gross profit after subtracting operational expense you'll find net operating profit/loss. After adding other non-operating income with non-operating profit/loss, we'll find net profit/loss before tax, and the last step is subtracting income tax expenses from net profit/loss before tax; then we'll find net profit/loss after tax. And from net profit/loss, we can easily understand whether the business is profitable or not. Here is an example of an income statement of a small business given below:

2. What is a statement of financial position? 

A statement of financial position is a company's financial statement that represents one company's assets, liabilities, and owners' equity. Mainly, the balance sheet is the full form of accounting's equation. We all know the equation of accounting: A = L + OE. Here, A refers to assets, L means liabilities, and OE means owners' equity. This is the short form of the accounting equation. It has expanded equation form, and this is A=L+OE+R-E-D. In a balance sheet, assets are always equal to liabilities and owners' equity. There are some categories in assets and liabilities; these are: Asset = current assets + non-current assets. Liabilities = current liabilities and non-current liabilities. One company's all types of assets will be equal to liabilities and equity. 

Here is an example of a small business balance sheet. It will help you to identify what a balance sheet looks like.

3. What is a statement of changes in equity? 

Every business is operated by an owner. There is someone behind every business who claims benefits from the business at the end of its operation or fiscal year, called the owner. In the start-up periods, the owner invests in the business as capital, and it can be cash or cash equivalents, tangible assets, or intangible assets. At the end of the year or its operational period, when an owner claims his/her portion from the business, it is called owner's equity. 

For calculating properly or keeping a record of owners' equity accurately, there is a financial statement called the statement of changes in equity. Statement of changes in equity is consistent with some elements they are now describing here for a little bit of your understanding. 

1. Opening Equity 

2. Additional investment during the year. 

3. Withdraw 

4. Profit/loss

5. Closing equity 

1. Opening Equity.

In a statement of changes in equity, there is something called opening equity. This is what the owner invests at the starting period of the business.

2. Additional Investment.

Additional investment means if the owner invests additional amounts of money after the primary investment during that year.

3. Withdrawal.

Withdrawal means that, like additional invest owners can withdraw money from the business. It always affects the owner's equity; withdrawals of money always subtract from the equity, reducing the owner's equity.

4. Profit/loss

Profits/losses create a major impact on equity. When businesses earn profit equity increases, and losses decrease the owner's equity.

5. Closing Equity 

Closing equity means after deducting withdrawals of money or loss from opening equity, the remaining equity in the business is called closing equity. It's assumed that one business entity performs its operation on a going concern basis, and that's why the previous year's closing balance is treated as the current year's opening balance. 

4. What is a statement of cash flows? 

The statement of cash flows is another important financial statement. Statements of cash flows are maintained to keep tracking the business's inflows and outflows of cash. While a business performs its operational activities for generating profit from sales or from other sources of income, it generates cash inflows and cash outflows. 

There are three elements of the statement of cash flows from the cash generated inside and outside of the business. In cash flow statements cash inflows and outflows generated from three sources which are given below:

1. Cash flows from operating activities 

2. Cash flows from investing activities 

3. Cash flows from financing activities.

Cash flows from operating activities are here cash inflows and outflows generated from current assets and from current liabilities' increasing & decreasing. 

Cash flows from investing activities means here cash generated from the business's non-current assets and from non-current liabilities. Increasing or decreasing non-current liabilities and assets creates an impact on the cash flows of a business. 

Cash flows from financing activities means here cash flows generated from financing activities. Owners invest in the business and also withdraw from the business; these create an impact on the business's cash inflows and outflows. 

From cash flows we can easily understand the company's current cash inflows or outflows. 

5. What are notes to the financial statements? 

Notes to the financial statements represent the company's general information, legal form of the company, registered office of the company, nature of the business, compliance with local laws, significant accounting policies, how they calculate depreciation, whether there are any special depreciation policies, and notes of the financial statements. 

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