In general, business owners start and run their own business in order to generate income or profit. To do this, they spend numerous hours developing their product or services, marketing it, closing a sale, and then deliver it to their customers. Aside from that they also spend time managing their people and their operations. How they manage these activities will either result into profit or loss. It may also determine if the company will grow or eventually closes down.
In order to know the result and status of the business, the company must have a periodic review of the financial statements.
What is a Financial Statement?
Financial statement comprises of financial reports periodically prepared by accountants or bookkeepers, at least every month, for the purpose of communicating the status and performance of the business to the stakeholders.
Stakeholders are users of the financial statements. It includes the business owner, employee, auditor, banks, governments, etc.
Importance of Financial Statements
Having a periodic financial statement gives the business owners, or any stakeholders, knowledge on what has happened financially in the business, and can also serve as basis in decision making.
Without reliable financial statements, business owners may not have an objective basis on how they decide in running their company and how they will grow it.
Types of Financial Statements
In general, the following are the basic financial statements that business owners must read periodically, at least monthly, in order to understand the financial status and performance of their business.
Statement of Financial Position
Also referred to as the Balance Sheet. This financial report shows the assets, liabilities and equity of the business as of a given period.
- Assets are the economic resources of the business. Normally held for sale or use in the current and long-term business operation. Example includes cash, receivables, inventory, investment and property, plant and equipment, and etc.
- Liabilities are the legal obligations of the business the resulted from the business operation. Example includes accounts payable, advances, loans payable such as chattel mortgage, accruals, etc.
- Equities are the claim of the owners in the business assets after liabilities are deducted. It is computed by subtracting all liabilities in the assets (Assets – Liabilities).
The main purpose of this statement is to understand what comprises the assets and how much assets the business owns. It also shows how these assets are financed, if either as debts or liabilities, or equities through capital contribution and result of operation.
Out of all the financial statements, the statement of financial position is considered the most important since it shows the overall condition and status of the business. For more information about balance sheets, you may refer to our other article What is the Use of the Balance Sheet?
The other financial statements are considered supporting statement.
Statement of Income and Expense
Also referred to as the Income Statement. This financial report shows the revenue (or sales), expenses, profit or income, and loss or deficit, for a given period.
- Revenue are the inflows resulting from sale of product, services or use of properties.
- Expenses are the outflows resulting from purchases or disbursements necessary to run the business. It’s normally divided into two types: cost of sales and operating expenses. Examples include: purchases of inventory, cost of goods sold, freight, salaries, rental, transportation, utilities, taxes and licenses, etc.
- Profit or Income is a positive result of the operation. It means the revenue is greater than the expenses.
- Loss or Deficit is a negative result of the operation. It means the revenue is less than the expenses.
The main purpose of the statement of income and expense is to report the result of the operation, if it’s positive (income) or negative (loss).
The result of operation goes to the equity of the business as shown in the statement of financial position. Profit or income increases the equity, while loss or deficit decreases the equity.
Statement of Cash Flow
Also referred to as the Cash Flow Statement. This financial report shows the cash movement and how it is used/managed by the business.
There are two types of cash flow statement, direct and indirect method. The most commonly used is the indirect method. Indirect method relies on the movement and changes in the balance sheet account and present it in three (3) activities: operating, investing, and financing.
- Operating activities are said to be activities that are frequently done in the business. In general, it pertains to the movement in current assets and current liabilities.
- Investing activities are said to be activities that are less frequent in nature of the business. In general, it pertains to the movement of the non-current assets.
- Financing activities are said to be activities that funds the business operation. In general, it pertains to the non-current liabilities and equities.
The main purpose of the statement of cash flow is to see the overall financial health of the business, and how well or poor it is managed.
Statement of Changes in Equity
Last but not the least financial statement. This shows: 1) the capital composition of the business, and 2) the result of the operation.
- Capital shows the amount contributed by the business owners in the business. Any additions or withdrawals during the period is shown.
- The result of operation is often reflected as “Retained Earnings” if positive result or “Deficit” if negative result.
Any dividend payment during the period is also reflected in this report.
Financial statements can be intimidating to look at when you are not an accountant or finance person. But nonetheless, it is relevant to understand and learn how to read because it can serve as useful basis or data in your business evaluations and decisions. For more detailed approach on how you can fully utilize your financial statement, you may attend our Understanding Financial Statements and Financial Ratios Workshop.
