Understanding financial statements

Do financial statements leave you confused? Don't fret. We've got you covered.

A financial statement – one of the most important management tools – can be an extremely daunting document, and few people truly understand the ins and outs of it. The purpose of a financial statement is to show the financial performance and position of a business, but much of the information is lost in a haze of confusing jargon and rows of obscure numbers. To make things clearer, here’s a quick and simple breakdown of the three types of financial statements.

Financial statements come in three forms: the income statement, the balance sheet and the cash flow statement.

1. Income statement

The income statement is a summary of a business’s financial position that compares income and expenses over a set period of time. The statement is usually annual, but can also be quarterly or even monthly. It is usually displayed as a long list, with earnings (listed by category) at the top, followed by expenses, then taxes and finally the net gain at the bottom – hence the saying “the bottom line”.

The income statement totals all of the business’s income, and subtracts from that the total expenses, taxes and interest to give the net earnings of the company. A positive figure indicates profit, while a negative one shows that the business has made a loss.

2. Balance sheet

While an income statement details financial information over a period of time, the balance sheet shows the company’s financial position on a specific date. The balance sheet indicates the assets, short and long-term liabilities and owner’s equity – in other words, what the company owns and how those assets were financed (either as debts to be repaid or from the owner’s or investors’ contributions). It provides an instant snapshot of the business’s financial position and can indicate where a company is struggling (for example, with too many short-term debts) or succeeding.

3. Cash flow statement

A cash flow statement, tracks the flow of money in and out of the company in the time between two points in time. It accounts for the changes in assets and liabilities between two (usually annual) balance sheets. The cash flow statement literally indicates the cash flowing into the business (such as payments by customers and interest earned) against the cash being used by, and flowing out of, the business (such as salaries, equipment costs and loan payments).

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