What are financial statements?

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Financial statements are summary reports that indicate the financial performance and position of a company, like how profitable it was in a given period of time, what were the costs & expenditures in that period, how much assets does it own, how much debt it has to pay, and more.

One way to evaluate a company’s financials is to look through its past performance. The major reports that summarizes any company’s past financial performance are called financial statements. 

Key takeaways

  • Financial statements are key reports that illustrate the financial performance & position of a company.
  • There are 4 major financial statements, they are the income statement, the balance sheet, the cash flow statement & statement of shareholder’s equity.
  • The importance of financial statements to investors.

There are four major financial statements that companies report

  1. Income Statement
  2. Balance Sheet
  3. Cash Flow Statement
  4. Statement of Shareholder’s Equity

Income Statement

The income statement (also called the profit & loss statement) focuses on reporting the revenues and expenses of a company in a specific period of time.  the income statement simply represents the following equation 

Profit (Loss) = Revenues – Expenses

It starts with adding the total revenues generated by the company operations in the specified period of time, then deducting the cost of goods sold (COGS). The result is called (gross profit), but our calculation doesn’t end here.

We also deduce other expenses like marketing & administrative costs, interest paid, etc. until we reach the net income, which any business aims to maximize.

Balance Sheet

A balance sheet indicates a snapshot of the financial position of a company by looking at what the company owns (its assets like lands, equipment, vehicles, etc.) and what it owes (its liabilities like debt, loans, bills to pay, etc.), plus the shareholders‘ equity. 

In other words, balance sheets show the assets a company owns and how it financed those assets, either by liabilities or by equity financing.

Thus, the balance sheet is represent through the following equation

Assets = Liabilities + shareholders equity

A balance sheet has to be balanced. This is because everything a company owns, was either financed by liabilities or equity.

Unlike the income statement, which reflects the financial performance over a specific period of time, the balance sheet is like a snapshot of a company taken at a point in time.

Let’s say a company buys land for EGP 100M and that it will be 50% financed through equity and 50% through debt. In that case , the company’s assets will have EGP 100M recorded, its liabilities will have EGP 50M and its equity will have EGP 50M.

Cash Flow Statement

A company can have a high net income, but can still suffer from not having enough cash, as they failed to adequately manage their cash flow. This might happen if a company sells its product to customers, but extends the sale credit to the customer. Although it’s considered as revenue/profit, the company will receive the actual cash after time. 

The purpose of cash flow statements is to track the cash inflows & outflows of the company. The cash flow statement includes cash movements made by the business through operations, investment, and financing that sum to net cash flows. The inflows and outflows of any money that is earned, but not yet received, is not included.

Statement of Shareholder’s Equity

Shareholders equity is the sum of the share capital, which is the amount of capital that shareholders injected into the company, the company accumulated retained earnings, and the current net income minus the dividends distributed to shareholders. 

A statement of shareholders’ equity is a section that reflects the changes in the shareholder’s equity from the beginning to the end of an accounting period.

Why are financial statements important?

Financial statements are widely used by many stakeholders including the company’s management, investors, lenders, and governments. The management uses it to understand the success of their plans, and to make smart operational and financial decisions.

Government agencies look through companies financial statements to ensure they are properly audited and taxation is correctly paid.

Research analysts use historical financial statements to analyze a company’s fundamentals to articulate a securities’ fair value and benchmark the financial ratios with other peers.

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