When it comes to assessing the overall financial standing of a company or organization, there are four primary financial statements that are typically prepared and reviewed. These financial statements are: Balance Sheet, Income Statement, Statement of Cash Flows and Statement of Changes in Equity.
Each statement has different data and a different purpose. And, while financial reporting software can be used to prepare these statements for you, it is still important to understand what each statement includes and the differences between them. Below is a review of each financial statement and their major differences:
The Balance Sheet
Summary: A snapshot of the financial position of a business or organization at a specific moment in time.
Purpose: To demonstrate a company’s financial position and its solvency (i.e. its ability to meet long-term financial obligations).
Data Included:
• Assets – The things the business owner owns or controls which add value to the business (e.g. cash, inventory, equipment)
• Liabilities – What the business owner owes to someone else (e.g. bank loans)
• Equity – The remaining capital the business owes to the owner. In other words, what is left after assets are used to pay off liabilities
Importance: The balance sheet demonstrates the financial health of a business at any given time. Is the business being well managed? Are there enough assets to pay off all liabilities if needed? The balance sheet reveals the business’s current strengths and weaknesses and is useful for future financial planning.
The Income Statement
Summary: The Income Statement reports the net profit or loss for a specific period of time.
Purpose: To show how profitable a company is. The income statement also reconciles the prior balance sheet with the current balance sheet.
Data Included:
• Income – What a business has earned (sales, revenue, dividends, etc.) for the given time period
• Expenses – What a business has paid out in that time period (salaries, wages, interest, rent, etc.)
Importance: The Income Statement shows how well a business is performing during a particular time period and why. How much income is coming in and where is it coming from? How is money being spent during the time period? The income statement is important to both lenders and investors who want to see that money is being handled properly.
The Statement of Cash Flows
Summary: The Statement of Cash Flows shows how cash is moved around the business or organization during a specific time period.
Purpose: To display cash inflows and cash outflows from activities such as operating, investing and financing. The statement of cash flows also reconciles cash changes from the beginning to the end of the balance sheet.
Data Included:
• Operating activities – Cash generated from the sale of products or services in the core business
• Investing activities – Cash spent on investments e.g. new equipment
• Financing activities – Cash flow from financing such as cash from a new debt or dividends paid to investors
Importance: Generating sufficient cash is the key to a healthy business. This report shows how well the business is doing in that venture. The statement of cash flows can also be used in developing a business strategy and long term planning.
The Statement of Changes in Equity
Summary: The equity statement gives details about the movement of owner’s equity over a period of time.
Purpose: To explain changes in retained earnings between the prior and current balance sheet dates.
Data Included:
• Net profit or loss
• Increases or decreases in share capital reserves
• Dividend payments to stockholders
• Other gains and losses (e.g. changes in revaluation reserve)
Importance: Owners invest in a business for a return and to maximize their wealth. This statement demonstrates how the financial performance of the business has affected their interest during the given time period.
SUMMARY: Although the four financial statements have some overlap, each one uses different data to tell a different story for a different purpose. Financial statement reporting software facilitates the preparation of these reports but business owners should study each one individually to get a well-rounded picture of how well the business is performing.