BBC Content Team
No matter the variations between businesses, they all share the commonality of financial statements. Financial statements are written documents that show the financial records of a business. The statements are notably significant due to them being used in multiple ways. Government agencies, accountants, and individual firms may audit the records to assure the correctness of taxes, financing, or investing (Murphy). Furthermore, financial statements serve as a large source of information in predicting how a company will do in the future. Statements contain three main portions of information, which are the balance sheet, income statement, and cash flow statement. All three provide the reader with different data on the business. How to analyze each is key in understanding how the company is functioning.
To start, balance sheets are a total overview of a business's "assets, liabilities, and stockholder equity as a snapshot in time" (Murphy). Usually, these snapshots are taken at the end of the company's fiscal year. A formula used to understand balance sheets is "Assets = (Liabilities + Owner's Equity)" (Murphy). An accurate balance sheet will fulfill the requirements of this formula. The number and specific type of assets/stockholder's equity can be found on this sheet. The liabilities section will provide all of the debts a company has and when they intend to pay them off. This section provides the reader with a breakdown of how the company did in the recent past.
Next up is the income statement which gives a thorough review of revenues, expenses, net income, and earnings per share. A difference between this and balance sheets is that income statements generally cover two to three years of data to create comparisons, while balance sheets are over a shorter time period. As the name suggests, income statements focus on the revenues and expenses of a business over some time. Just as with balance sheets, there is a formula associated with the income statement. This formula is "Net Income = (Revenue - Expenses)" (Murphy). Investors often use the income statement to see how well a company is doing in sales.
Lastly, the cash flow statement is included. This displays the efficiency of a company in satisfying their goals. Unlike the previous two sections, there is no formula for cash flow statements. Nevertheless, it contains valuable information, showing how profitable a company can operate. This includes day-to-day operations, investing activities, and financing activities. This portion of the financial statement can be considered a general mix of both the income statement and balance sheet.
To conclude, financial statements are a source of relevant information regarding a company. However, they leave the interpretation of the facts to the reader. Different investors may see different potentials for a company from the same information. To come to an accurate conclusion, one should be able to analyze a financial statement effectively. Only when they do this, will one be able to successfully predict the future of a company.
Murphy, Chris B. “How to Interpret Financial Statements.” Investopedia, Investopedia, 13 May 2020, www.investopedia.com/terms/f/financial-statements.asp.